Abstract
The sovereign CDS market can predict future stock index returns, government bond yields, as well as real economic activities such as GDP growth and PMI across countries. A strategy that buys stock indices of countries in the top quintile (whose creditworthiness improved the most in the previous quarter according to sovereign CDSs) and sells indices from the bottom quintile generates an average return of 15% per year. The sovereign CDS market contains information on the creditworthiness of the underlying countries. Stock and bond markets gradually catch up with that information, especially during the days with credit rating outlook changes.
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