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Credit-risk valuation in the sovereign CDS and bonds markets: Evidence from the euro area crisis

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  • Arce, Oscar
  • Mayordomo, Sergio
  • Peña, Juan Ignacio

Abstract

We analyse the extent to which prices in the sovereign credit default swap (CDS) and bond markets reflect the same information on credit risk in the context of the current crisis of the European Monetary Union (EMU). We first document that deviations between CDS and bond spreads are related to counterparty risk, common volatility in EMU equity markets, market illiquidity, funding costs, flight-to-quality, and the volume of debt purchases by the European Central Bank (ECB) in the secondary market. Based on this we conduct a state-dependent price-discovery analysis that reveals that the levels of the counterparty risk and the common volatility in EMU equity markets, and the banks' agreements to accept losses on their holdings of Greek bonds impair the ability of the CDS market to lead the price discovery process. On the other hand, the funding costs, the flight-to-quality indicator and the volume of debt purchases by the ECB worsen the efficiency of the bond market.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 35 (2013)
Issue (Month): C ()
Pages: 124-145

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Handle: RePEc:eee:jimfin:v:35:y:2013:i:c:p:124-145

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Web page: http://www.elsevier.com/locate/inca/30443

Related research

Keywords: Sovereign credit default swaps; Sovereign bonds; Credit spreadss; Price discovery;

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Citations

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Cited by:
  1. Carmen Broto & Gabriel Perez-Quiros, 2013. "Disentangling contagion among sovereign cds spreads during the european debt crisis," Banco de Espa�a Working Papers 1314, Banco de Espa�a.
  2. Jacob Gyntelberg & Peter Hördahl & Kristyna Ters & Jörg Urban, 2013. "Intraday dynamics of euro area sovereign CDS and bonds," BIS Working Papers 423, Bank for International Settlements.
  3. Sergio Mayordomo & Juan Ignacio Peña & María Rodríguez-Moreno, 2012. "Liquidity Commonalities in the Corporate CDS Market around the 2007-2012 Financial Crisis," Faculty Working Papers 23/12, School of Economics and Business Administration, University of Navarra.
  4. Tropeano, D., 2013. "Financial Fragility in the Current European crisis," CITYPERC Working Paper Series 2013-09, Department of International Politics, City University London.
  5. Maria Abascal & Tatiana Alonso & Sergio Mayordomo, 2013. "Fragmentation in European Financial Markets: Measures, Determinants, and Policy Solutions," Working Papers 1322, BBVA Bank, Economic Research Department.
  6. Fulli-Lemaire, Nicolas, 2013. "A Tale of Two Eurozones: Banks’s Funding, Sovereign Risk & Unconventional Monetary Policies," MPRA Paper 49072, University Library of Munich, Germany.

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