The Reaction of European Credit Default Swap Spreads to the U.S. Credit Rating Downgrade

Abstract

Using data consisting of Credit Default Swap (CDS) spreads, this study examines CDS spreads for nearly all European countries surrounding the August 5th, 2011 Sovereign Credit Rating downgrade of the United States. While U.S. CDS spreads remained at relatively normal levels, we find a surge in European CDS spreads during the ten-day period surrounding the U.S. downgrade. At their highest level during this ten-day period, CDS spreads were nearly 25 percent higher than normal indicating that the CDS market perceived that the U.S. downgrade dramatically affected the likelihood of default in European countries. We find that European countries with the smallest GDP per capita and countries that had not recently been downgraded had the largest increase in CDS spreads.