Pricing of Sovereign Credit Risk: Evidence from Advanced Economies during the Financial Crisis

Pricing of Sovereign Credit Risk: Evidence from Advanced Economies during the Financial Crisis

We investigate the pricing of sovereign credit risk over the period 2008–10 for selected advanced economies by examining two widely‐used indicators: sovereign credit default swap (CDS) and relative asset swap (RAS) spreads. Cointegration analysis suggests the existence of an imperfect market arbitra...

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Bibliographic Details
Published in:International finance (Oxford, England) Vol. 16; no. 2; pp. 161 - 188
Main Authors: Alper, C. Emre, Forni, Lorenzo, Gerard, Marc
Format: Journal Article
Language:English
Published: Oxford Blackwell Publishing Ltd 01-06-2013
Subjects:
Credit default swaps
Credit risk
Derivatives
Economic crisis
Risk exposure
Sovereign debt
Studies
United States > US
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Summary:We investigate the pricing of sovereign credit risk over the period 2008–10 for selected advanced economies by examining two widely‐used indicators: sovereign credit default swap (CDS) and relative asset swap (RAS) spreads. Cointegration analysis suggests the existence of an imperfect market arbitrage relationship between the cash (RAS) and the derivatives (CDS) markets, with price discovery taking place in the latter. Likewise, panel regressions aimed at uncovering the fundamental drivers of the two indicators show that the CDS market, although less liquid, has provided a better signal for sovereign credit risk during the period of the recent financial crisis.
Bibliography:ark:/67375/WNG-NH6D0DKF-K
ArticleID:INFI12028
istex:F4CB5B11F68CB05ED5B27944378AE4895A6CA8E3
The authors are indebted to Jennie Bai, Joe di Censo, Marco Naldi, and Jari Stehn, for discussions and comments, as well as Daniel Leigh for preliminary estimations of the fundamental determinants of the CDS and RAS spreads. We would also like to thank the participants of the IMF FAD seminar series (Washington, December 2011). The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy.
ISSN:1367-0271
1468-2362
DOI:10.1111/j.1468-2362.2013.12028.x