Sovereign CDS Market Research Articles

Stability and risk contagion in the global sovereign CDS market under Russia-Ukraine conflict

As a leading indicator of sovereign debt risk, the performance of the sovereign CDS market during the Russia-Ukraine conflict deserves attention. This paper calculates the marginal net spillover index, constructs the sovereign CDS network based on the index, identifies the important countries in the network, and analyzes the network stability considering the differences in the roles of the countries in the network. By further analyzing the daily sovereign CDS network before and after the Russia-Ukraine conflict, we show the evolution pattern of the risk of the important countries in the network and the main risk contagion paths between countries. The paper shows that the Russia-Ukraine conflict significantly exacerbated the network’s overall risk level and instability. The major transmitters in the sovereign CDS network are characterized by the risk switch from receiving to transmitting, and the major receivers are characterized by the risk switch from latent to manifest. The risk contagion process is characterized by four stages: risk contagion to neighboring countries, risk exacerbation between Russia and Ukraine, further outward spillover, and weakening but persistent spillover. This study helps to provide a reference for investors to mitigate risk contagion in the sovereign CDS market.

Global and local information efficiency: An examination of samuelson's dictum

The global version of Samuelson's Dictum is the conjecture that there is more informational inefficiency for global information than for country-specific information. Consistent with this conjecture, we find that sovereign CDS spreads can predict future sovereign bond yields of their underlying countries and this predictive power arises almost entirely from CDS spread's global—rather than country-specific—component. Noting the striking similarities between the evidence in stock and sovereign bond markets, we examine the underlying mechanism for the results in both markets in parallel and find further similarities across these two markets. In both cases, information appears to flow in one direction: from the sovereign CDS market to stock and sovereign bond markets and not the other way around. Information transmission occurs mostly during the days surrounding announcements of credit-rating or outlook changes, especially downgrades. These results are broadly consistent with a setup in which information acquisition and processing is costly.

Contagion in the Euro area sovereign CDS market: a spatial approach

PurposeThis paper explores whether the Euro-area sovereign credit default swap market is prone to contagion effects. It investigates whether the sharp increase in sovereign CDS spread of a given country is due to a deterioration of the macroeconomic variables or some form of contagion.Design/methodology/approachFor this purpose, the authors use an innovative approach, i.e. spatial econometrics. Although modeling spatial dependence is an attractive challenge, its application in the field of finance remains limited.FindingsThe empirical findings show strong evidence of spatial dependence highlighting the presence of pure contagion. Furthermore, evidence of wake-up call contagion-increased sensitivity of investors to fundamentals of neighboring countries and shift contagion-increased sensitivity to common factors are well recorded.Originality/valueThis study aims to study a crucial financial issue that gained increased research interest, i.e. financial contagion. A methodological contribution is made by extending the standard spatial Durbin model (SDM) to analyze and differentiate between several forms of contagion. The results can be used to understand how shocks are spreading through countries.

Sovereign bond and CDS market contagion: A story from the Eurozone crisis

We examine the asymmetric and nonlinear nature of the cross- and intra-market linkages of eleven EMU sovereign bond and CDS markets during 2006–2018. By adopting the excess correlation concept of Bekaert et al. (2005) and the local Gaussian correlation approach of Tjøstheim and Hufthammer (2013), we find that contagion phenomena occurred during two major phases. The first, extends from late 2009 to mid 2011 and concerns the outright contagion transmission from EMU South bond markets towards all European CDS markets. The second, is during the revived fears of a Greek exit in November 2011 and is characterized by contagion from (i) CDS spreads in the EMU South towards bond yields in the same bloc and Belgium, and (ii) from Italian and Spanish CDS spreads towards all European CDS spreads. Consistent with their “too big to bail out” status, Italy and Spain emerge as pivotal for the evolution of sovereign credit risk across the Eurozone. Our examination of the relevant mechanisms, highlights the importance of credit risk over liquidity risk, and the containment effect of the naked CDS ban.

Sovereign Credit Default Swaps and the Currency Forward Bias

We study the links between sovereign credit risk and the currency forward bias. In a setting of defaultable sovereign bonds, we show that the forward bias can be negatively linked to sovereign credit risk. We confirm empirically that the forward bias is negatively associated to sovereign CDS spreads and systematically across both developed and emerging countries but the effect is more pronounced for emerging countries. Furthermore, we show that the forward bias decreases after the inception of the sovereign CDS market. Overall, our results underscore the distinct role of the sovereign CDS market in enhancing price efficiency in currency forward and spot markets.

The impact and the contagion effect of natural disasters on sovereign credit risk. An empirical investigation

This paper investigates the relationship between natural disasters and the reaction of sovereign CDS spread in Europe. By applying an event study methodology during the period January 2007–December 2021 on an original database in which we identify 92 natural disasters in 17 European countries, we assess the reaction of the sovereign CDS market to a natural disaster. We find a heterogeneous response of the European sovereign risk to a natural disaster, as the response of the sovereign CDS market differs from region to region. The advent of a natural disaster can increase inequality between the regions due to the higher cost of credit for sovereigns and the reduced scope for manoeuvring public finances. Also, the results of the contagion effect confirm the hypothesis of a cross-border propagation effect, as natural disaster, in general, is not local event but spreads to other countries.

A Global Version of Samuelson's Dictum

Samuelson’s Dictum refers to the conjecture that there is more informational inefficiency at the aggregate stock market level than at the individual stock level. Our paper recasts it in a global setup: there should be more informational inefficiency at the global level than at the country level. We find that sovereign CDS spreads can predict future stock market index returns, GDP, and PMI of their underlying countries. Consistent with the global version of Samuelson’s Dictum, the predictive power for both stock returns and macro variables is almost entirely from the global, rather than country-specific, information from the sovereign CDS market. (JEL G12, G14, G17)

US macroeconomic surprises and the emerging‐market sovereign CDS market

AbstractOur primary aim is to examine whether US macroeconomic surprises affect the slope of the term structure of ‘sovereign credit default swap’ (SCDS) spreads in emerging markets. Our empirical results show that positive (negative) US macroeconomic surprises are likely to reduce (increase) the term structure slope of SCDS spreads in emerging countries. We find that the slope values in emerging markets are positively related to future market returns over 1‐ and 2‐day horizons. Our results provide general support for the future informational role played by SCDS spreads for the national stock market within emerging markets.

Under-reaction in the sovereign CDS market

The sovereign CDS market has developed rapidly for two decades and currently has a gross notional amount of more than a trillion dollars. We document a strong momentum effect in this market, which cannot be explained by a large set of risk factors. These momentum returns are positively skewed and higher during recessions. Consistent with the interpretation that this momentum effect is due to investors’ initial underreaction to sovereign credit information followed by corrections, our evidence shows that the momentum returns tend to be higher during the months surrounding announcements of credit rating or outlook changes of the underlying countries.

The Nexus between Sovereign CDS and Stock Market Volatility: New Evidence

This paper extends the studies published to date by performing an analysis of the causal relationships between sovereign CDS spreads and the estimated conditional volatility of stock indices. This estimation is performed using a vector autoregressive model (VAR) and dynamically applying the Granger causality test. The conditional volatility of the stock market has been obtained through various univariate GARCH models. This methodology allows us to study the information transmissions, both unidirectional and bidirectional, that occur between CDS spreads and stock volatility between 2004 and 2020. We conclude that CDS spread returns cause (in the Granger sense) conditional stock volatility, mainly in Europe and during the sovereign debt crisis. This transmission dynamic breaks down during the COVID-19 period, where there are high bidirectional relationships between the two markets.

Sovereign CDS and mutual funds: Global evidence

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.

A Global Version of Samuelson’s Dictum

Samuelson’s Dictum refers to the conjecture that there is more informational inefficiency at the aggregate stock market level than at the individual stock level. Our paper recasts it in a global setup: there should be more informational inefficiency at the global level than at the country level. We find that sovereign CDS spreads can predict future stock market index returns, GDP, and PMI of their underlying countries. Consistent with the global version of Samuelson’s Dictum, the predictive power for both stock returns and macro variables is almost entirely from the global, rather than country-specific, information from the sovereign CDS market.

Network Risk in the European Sovereign CDS Market

This paper applies novel tools from spatial econometrics to measure, quantifyand predict sovereign CDS spreads. Network risk is modelled by making each sovereignísCDS spread a function of the CDS spreads of its ìneighborsî in the Önancial network. Themain Öndings of the paper are: (1) the network model improves forecasting accuracy by 15% to 20%; (2) exogenous Önancial shocks propagate in the network of sovereigns and 40 %to 50% of the total e§ect is due to indirect (network) e§ects. These Öndings suggest analternative explanation to the well-known credit spread puzzle. To rationalize the Öndingsthe paper develops a simple structural network model of sovereign credit risk with Önancialcross-holdings and multiple equilibria.

Under-reaction in the Sovereign CDS Market

The sovereign CDS market has developed rapidly for two decades and currently has a gross notional amount of more than a trillion dollars. We document a strong momentum effect in this market, which cannot be explained by a large set of risk factors. These momentum returns are positively skewed and higher during recessions. Consistent with the interpretation that this momentum effect is due to investors’ initial underreaction to sovereign credit information followed by corrections, our evidence shows that the momentum returns tend to be higher during the months surrounding announcements of credit rating or outlook changes of the underlying countries.

Spillovers among sovereign CDS, stock and commodity markets: A correlation network perspective

In the wake of the globalization of financial markets, studying spillovers among different asset markets, especially spillovers that include sovereign CDS markets, is of vital importance. This paper attempts to build a spillover network to investigate the complex interactions within the system of sovereign CDS, stock and commodity markets by adopting the spillover index based on forecast error variance (FEV) decomposition. The results reveal that emerging countries have larger average spillovers than developed countries with regard to sovereign CDS-to-stock returns spillovers, while the developed countries contribute more average spillovers than the emerging countries in the opposite direction. Moreover, the sovereign CDS market and the commodity market still demonstrate a relatively important role during certain periods although stock markets always occupy the dominant position during every phase. Our findings provide new insights into spillovers among the major global asset markets using a network perspective, which is valuable for regulation of financial markets, asset allocation and portfolio risk management.

The Price Discovery Mechanism between Sovereign Bond and Sovereign CDS Market: Studies in Selected Countries

This paper employs the multivariate VAR model to examine the mechanic work of price discovery process between sovereign CDS market and the associated sovereign bond market in contexts of five European and Asian countries, including Vietnam, Korea, Portugal, Italy and France from the beginning of 2008 to the end of April, 2017. The study accentuates on three aspects: the short-term interaction nexus between the sovereign CDS and the associated-sovereign bond market, the long-term co-movement between them and the discovery of which market plays the leading role in the pricing process. The results evidence the short-run and long-run relationship for the two markets. Particularly, the empirical test results support for the predominant role of the sovereign CDS market in the price discovery process in the bulk of sample entities. This might suggests for the governments to use CDS prices as the future indicator for predicting the volatility of debt markets.

Does Monetary Policy Impact Market Integration? Evidence from Developed and Emerging Markets

This paper shows that FED policy announcements lead to a significant increase in international co-movement in the cross-section of equity and particularly sovereign CDS market. The effect is strongest for emerging markets, when the FED relaxes unconventionary monetary policies, and for countries that are open to the trading of goods and flows, even with floating exchange rates. The announcements also affect closed economies whose currencies are pegged to the dollar. The evidence is consistent with recent theories of a global financial cycle and the pricing of a FED put. In contrast, ECB announcements hardly affect co-movement, even in the Eurozone.

Economic and Financial Determinants of Credit Risk Premiums in the Sovereign CDS Market*

We specify and estimate no-arbitrage models for sovereign CDS contracts by assuming that the country’s default intensity depends on observable economic and …nancial indicators. We estimate these models using a sample of twenty-eight countries, three CDS maturities, and over a decade of daily data. The models provide a good …t. The impact of the economic and …nancial variables on spreads is consistent with economic intuition. Spreads increase as a function of stock market and exchange rate volatility, but decrease as a function of interest rates and stock market returns. The magnitudes of these impacts vary substantially across countries and over time. Estimated risk premiums are also highly time-varying and peak during the 2008 …nancial crisis for nearly all countries. For European countries, the risk premiums are also high during the Eurozone debt crisis. In periods of market stress and high CDS spreads, the increase in market risk premiums is even larger than the increase in default probabilities. The cross-sectional variation in risk premiums across countries is high, also in non-crisis periods.

Simulation of sovereign CDS market based on interaction between market participant

A research for distributional property of financial asset is the subject of intense interest not only for financial theory but also for practitioner. Such respect is no exception to CDS market. The CDS market, which began to receive attention since the global financial debacle, is not well researched despite of the importance of research necessity. This research introduces creation of CDS market and use Ising system utilizing occurrence characteristics (to shift risk) as an important factor. Therefore the results of this paper would be of great assistance to both financial theory and practice. From this study, not only distributional property of the CDS market but also various statistics like multifractal characteristics could promote understanding about the market. A salient point in this study is that countries are mainly clustering into 2 groups and it might be because of market situation and geographical characteristics of each country. This paper suggested 2 simulation parameters representing this market based on understanding such CDS market situation. The estimated parameters are suitable for high and low risk event of CDS market respectively and these two parameters are complementary and can cover not only basic statistics but also multifractal properties of most countries. Therefore these estimated parameters can be used in researches preparing for a certain event (high or low risk). Finally this research will serve as a momentum double-checking indirectly the performance of Ising system based on these results.

The Macro-Informational Role of Derivatives: Evidence from the Sovereign CDS Market

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.