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Non-default Component of Sovereign Emerging Market Yield Spreads and its Determinants: Evidence from Credit Default Swap Market

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  • Kucuk, Ugur N.

Abstract

This article shows that a sizable component of emerging market sovereign yield spreads is due to factors other than default risk, such as liquidity. The author estimates the non-default component of the yield spreads as the basis between the actual credit default swap (CDS) premium and the hypothetical CDS premium implied by emerging market bond yields. On average, the basis is large and positive for speculative-grade bonds and slightly negative for investment-grade bonds. The large positive basis for speculative-grade bonds supports the existence of speculation in the CDS market when the underlying's credit quality is bad. The author studies the effects of bond liquidity, liquidity in the CDS market, equity market performance, and macroeconomic variables on the non-default component of the emerging market yield spreads. The results show that bond liquidity has a significant and positive effect on the CDS–bond basis of investment-grade bonds. The results suggest that the liquid bonds of investment-grade bonds are more expensive relative to the prices implied their CDS premiums. However, the results are somewhat mixed and even contrary for the speculative-grade bond sample.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 27428.

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Date of creation: 01 May 2010
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Publication status: Published in The Journal of Fixed Income Spring 2010.19(2010): pp. 44-66
Handle: RePEc:pra:mprapa:27428

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Keywords: Emerging Market Sovereign Bonds; Credit Risk; Credit Default Swaps; Basis; Liquidity; Emerging Market Equity Markets;

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References

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Citations

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Cited by:
  1. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.
  2. Hammoudeh, Shawkat & Liu, Tengdong & Chang, Chia-Lin & McAleer, Michael, 2013. "Risk spillovers in oil-related CDS, stock and credit markets," Energy Economics, Elsevier, vol. 36(C), pages 526-535.
  3. Frolova, Elvina & Fantazzini, Dean, 2012. "Credit default swaps and CDS-bond basis with Russian companies: a review and an analysis of the effects of the short selling ban during the second great contraction," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 25(1), pages 3-24.
  4. Küçük, Ugur N., 2009. "Emerging Market Local Currency Bond Market, Too Risky to Invest?," MPRA Paper 21878, University Library of Munich, Germany.
  5. Kucuk, Ugur N., 2009. "Dynamic Sources of Sovereign Bond Market Liquidity," MPRA Paper 19677, University Library of Munich, Germany.

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