Advanced Search
MyIDEAS: Login to save this paper or follow this series

Sovereign CDS and Bond Pricing Dynamics in the Euro-area

Contents:

Author Info

  • Giorgia Palladini
  • Richard Portes

Abstract

This analysis tests the price discovery relationship between sovereign CDS premia and bond yield spreads on the same reference entity. The theoretical no-arbitrage relationship between the two credit spreads is confronted with daily data from six Euro-area countries over the period 2004-2011. As a first step, the supposed non stationarity of the two series is verified. Then, we examine whether the non-stationary CDS and bond spreads series are bound by a cointegration relationship. Overall the cointegration analysis confirms that the two prices should be equal to each other in equilibrium, as theory predicts. Nonetheless the theoretical value [1, -1] for the cointegrating vector is rejected, meaning that in the short run the cash and synthetic market's valuation of credit risk differ to various degrees. The VECM analysis suggests that the CDS market moves ahead of the bond market in terms of price discovery. These findings are further supported by the Granger Causality Test: for most sovereigns in the sample, past values of CDS spreads help to forecast bond yield spreads. Short-run deviations from the equilibrium persist longer than it would take for participants in one market to observe the price in the other. That is consistent with the hypothesis of imperfections in the arbitrage relationship between the two markets.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w17586.pdf
Download Restriction: Access to the full text is generally limited to series subscribers, however if the top level domain of the client browser is in a developing country or transition economy free access is provided. More information about subscriptions and free access is available at http://www.nber.org/wwphelp.html. Free access is also available to older working papers.

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17586.

as in new window
Length:
Date of creation: Nov 2011
Date of revision:
Handle: RePEc:nbr:nberwo:17586

Note: AP IFM
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Eli M Remolona & Michela Scatigna & Eliza Wu, 2007. "Interpreting sovereign spreads," BIS Quarterly Review, Bank for International Settlements, Bank for International Settlements, March.
  2. Hiro Y. Toda & Peter C.B. Phillips, 1991. "Vector Autoregression and Causality," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 977, Cowles Foundation for Research in Economics, Yale University.
  3. Lóránt Varga, 2009. "The information content of Hungarian sovereign CDS spreads," MNB Occasional Papers, Magyar Nemzeti Bank (the central bank of Hungary) 2009/78, Magyar Nemzeti Bank (the central bank of Hungary).
  4. Houweling, P. & Hoek, J. & Kleibergen, F.R., 1999. "The Joint Estimation of Term Structures and Credit Spreads," Econometric Institute Research Papers, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute EI 9916-/A, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  5. Dion Bongaerts & Frank De Jong & Joost Driessen, 2011. "Derivative Pricing with Liquidity Risk: Theory and Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, American Finance Association, vol. 66(1), pages 203-240, 02.
  6. Haibin Zhu, 2006. "An Empirical Comparison of Credit Spreads between the Bond Market and the Credit Default Swap Market," Journal of Financial Services Research, Springer, Springer, vol. 29(3), pages 211-235, June.
  7. Haug, Alfred A., 1996. "Tests for cointegration a Monte Carlo comparison," Journal of Econometrics, Elsevier, Elsevier, vol. 71(1-2), pages 89-115.
  8. Gregory, A.W. & Hansen, B.E., 1992. "Residual-Based Tests for Cointegration in Models with Regime Shifts," RCER Working Papers, University of Rochester - Center for Economic Research (RCER) 335, University of Rochester - Center for Economic Research (RCER).
  9. Thornton, Daniel L & Batten, Dallas S, 1985. "Lag-Length Selection and Tests of Granger Causality between Money and Income," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 17(2), pages 164-78, May.
  10. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(11), pages 2789-2811, November.
  11. Fontana, Alessandro & Scheicher, Martin, 2010. "An analysis of euro area sovereign CDS and their relation with government bonds," Working Paper Series, European Central Bank 1271, European Central Bank.
  12. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
  13. Markus K. Brunnermeier, 2008. "Deciphering the Liquidity and Credit Crunch 2007-08," NBER Working Papers 14612, National Bureau of Economic Research, Inc.
  14. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, American Finance Association, vol. 56(6), pages 2177-2207, December.
  15. Ana Fostel & John Geanakoplos, 2011. "Tranching, CDS and Asset Prices: How Financial Innovation Can Cause Bubbles and Crashes," Levine's Working Paper Archive 786969000000000192, David K. Levine.
  16. Ammer, John & Cai, Fang, 2011. "Sovereign CDS and bond pricing dynamics in emerging markets: Does the cheapest-to-deliver option matter?," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 21(3), pages 369-387, July.
  17. Hogan, Steve & Jarrow, Robert & Teo, Melvyn & Warachka, Mitch, 2004. "Testing market efficiency using statistical arbitrage with applications to momentum and value strategies," Journal of Financial Economics, Elsevier, Elsevier, vol. 73(3), pages 525-565, September.
  18. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 231-254.
  19. Allan W. Gregory & James M. Nason, 1991. "Testing for Structural Breaks," Working Papers, Queen's University, Department of Economics 827, Queen's University, Department of Economics.
  20. Lorenzo Codogno & Carlo Favero & Alessandro Missale, 2003. "Yield spreads on EMU government bonds," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 18(37), pages 503-532, October.
  21. Ebner, André, 2009. "An empirical analysis on the determinants of CEE government bond spreads," Emerging Markets Review, Elsevier, Elsevier, vol. 10(2), pages 97-121, June.
  22. Pierre Perron, 2005. "Dealing with Structural Breaks," Boston University - Department of Economics - Working Papers Series, Boston University - Department of Economics WP2005-017, Boston University - Department of Economics.
  23. Peter G. Dunne & Michael J. Moore & Richard Portes, 2007. "Benchmark Status in Fixed-Income Asset Markets," Journal of Business Finance & Accounting, Wiley Blackwell, Wiley Blackwell, vol. 34(9-10), pages 1615-1634.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Alter, Adrian & Beyer, Andreas, 2013. "The dynamics of spillover effects during the European sovereign debt crisis," Working Paper Series, European Central Bank 1558, European Central Bank.
  2. Avino, Davide & Cotter, John, 2013. "Sovereign and bank CDS spreads: two sides of the same coin for European bank default predictability?," MPRA Paper 56782, University Library of Munich, Germany.
  3. Dimitris A. Georgoutsos & Petros Migiakis, 2012. "Heterogeneity of the determinants of euro-area sovereign bond spreads; what does it tell us about financial stability?," Working Papers, Bank of Greece 143, Bank of Greece.
  4. Giovanni Calice & RongHui Miao & Filip Sterba & Borek Vasicek, 2013. "Short-Term Determinants of the Idiosyncratic Sovereign Risk Premium: A Regime-Dependent Analysis for European Credit Default Swaps," Working Papers, Czech National Bank, Research Department 2013/13, Czech National Bank, Research Department.
  5. Alter, Adrian & Beyer, Andreas, 2012. "The dynamics of spillover effects during the European sovereign debt turmoil," CFS Working Paper Series, Center for Financial Studies (CFS) 2012/13, Center for Financial Studies (CFS).
  6. Ratner, Mitchell & Chiu, Chih-Chieh (Jason), 2013. "Hedging stock sector risk with credit default swaps," International Review of Financial Analysis, Elsevier, Elsevier, vol. 30(C), pages 18-25.
  7. Carmen Broto & Gabriel Perez-Quiros, 2013. "Disentangling contagion among sovereign cds spreads during the european debt crisis," Banco de Espa�a Working Papers, Banco de Espa�a 1314, Banco de Espa�a.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:17586. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.