Sovereign CDS and mutual funds: Global evidence

Abstract

In this paper, we study the impact of sovereign CDS on equity mutual funds across 24 developed and emerging market countries. Our investigation builds on the premise that mutual funds flow and performance respond negatively to increased default risk as measured via sovereign CDS entities. As predicted by our theory, we find that i) sovereign CDS spreads are indeed associated with decreased mutual funds return performance and ii) sovereign CDS spreads covary negatively with subsequent fund flow. This is consistent with investors being sensitive to the pricing information conveyed by the sovereign CDS market. Finally, we find that the impact of sovereign CDS spreads on mutual funds’ performance and flow is more pronounced among emerging market countries. Overall, these findings imply that mutual funds players could make extensive use of the information arising from CDS trading activity. In explaining these results, we emphasize the important implications for investors in mutual funds’ assets portfolios and for country-specific equity funds.