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Government Intervention and the CDS Market: A Look at the Market's Response to Policy Announcements During the 2007-2009 Financial Crisis

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  • Caitlin Ann Greatrex

    (Iona College, Department of Economics)

  • Erick W. Rengifo

    (Fordham University, Department of Economics)

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    Abstract

    This paper adds to the literature on the financial markets' reaction to government interventions during the 2007-2009 financial crisis by analyzing the response of US firms' credit default swap spreads to key government actions. We find that the government measures taken to stabilize both the financial sector and the overall economy were generally well-received by CDS market participants, reducing perceived credit risk across a broad cross-section of firms. Financial firms responded most favorably to financial sector policies and interest rate cuts, with announcement date abnormal CDS spread changes of -5 and -2 percent, respectively. Non-financial firms responded most favorably to conventional fiscal and monetary policy tools with spread reductions of approximately one percent upon announcement of these measures. In a cross-sectional regression analysis, we find that size, recent performance, profitability, and stock returns are key factors in explaining the financial sectors response to government actions.

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    Bibliographic Info

    Paper provided by Fordham University, Department of Economics in its series Fordham Economics Discussion Paper Series with number dp2010-12.

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    Date of creation: 2010
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    Handle: RePEc:frd:wpaper:dp2010-12

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    Web page: http://www.fordham.edu/economics/
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    1. Ben S. Bernanke & Kenneth N. Kuttner, 2004. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," NBER Working Papers 10402, National Bureau of Economic Research, Inc.
    2. Michael R King, 2009. "Time to buy or just buying time? The market reaction to bank rescue packages," BIS Working Papers 288, Bank for International Settlements.
    3. Murillo Campello & John Graham & Campbell R. Harvey, 2009. "The Real Effects of Financial Constraints: Evidence from a Financial Crisis," NBER Working Papers 15552, National Bureau of Economic Research, Inc.
    4. Fabio Panetta & Thomas Faeh & Giuseppe Grande & Corrinne Ho & Michael King & Aviram Levy & Federico M. Signoretti & Marco Taboga & Andrea Zaghini, 2009. "An assessment of financial sector rescue programmes," Questioni di Economia e Finanza (Occasional Papers) 47, Bank of Italy, Economic Research and International Relations Area.
    5. International Monetary Fund, 2009. "Macroeconomic Fundamentals, Price Discovery and Volatility Dynamics in Emerging Markets," IMF Working Papers 09/147, International Monetary Fund.
    6. International Monetary Fund, 2009. "How to Stop a Herd of Running Bears? Market Response to Policy Initiatives During the Global Financial Crisis," IMF Working Papers 09/204, International Monetary Fund.
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    Cited by:
    1. Klomp, Jeroen, 2013. "Government interventions and default risk: Does one size fit all?," Journal of Financial Stability, Elsevier, vol. 9(4), pages 641-653.

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