Credit-Risk Valuation in the Sovereign CDS and Bonds Markets: Evidence from the Euro Area Crisis
AbstractWe 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 InfoPaper provided by School of Economics and Business Administration, University of Navarra in its series Faculty Working Papers with number 22/12.
Length: 47 pages
Date of creation: 21 Dec 2012
Date of revision:
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Web page: http://www.unav.es/facultad/econom
sovereign credit default swaps; sovereign bonds; credit spreads; price discovery;
Other versions of this item:
- Arce, Oscar & Mayordomo, Sergio & Peña, Juan Ignacio, 2013. "Credit-risk valuation in the sovereign CDS and bonds markets: Evidence from the euro area crisis," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 124-145.
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-01-07 (All new papers)
- NEP-CBA-2013-01-07 (Central Banking)
- NEP-EEC-2013-01-07 (European Economics)
- NEP-FMK-2013-01-07 (Financial Markets)
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