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Liquidity spillovers in sovereign bond and CDS markets: An analysis of the Eurozone sovereign debt crisis

Listed author(s):
  • Calice, Giovanni
  • Chen, Jing
  • Williams, Julian
Registered author(s):

    At the end of 2009, countries in the Eurozone (euro area) began to experience a sudden divergence of bond yields as the market perception of sovereign default risk increased. The theory of complete markets suggests that sovereign debt and credit default swap (CDS) credit spreads should track each other closely. In addition, liquidity risk should be priced into both instruments in such a way that buying exposure to the same default risk is identically priced. We use a time-varying vector autoregression framework to establish the credit and liquidity spread interactions over the 2009–2010 crisis period. We find substantial variation in the patterns of the transmission effect between maturities and across countries. Our major result is that, for several countries, including Greece, Ireland and Portugal the liquidity of the sovereign CDS market has a substantial time varying influence on sovereign bond credit spreads. This evidence is of particular importance in the current policy context.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0167268111002629
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    Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

    Volume (Year): 85 (2013)
    Issue (Month): C ()
    Pages: 122-143

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    Handle: RePEc:eee:jeborg:v:85:y:2013:i:c:p:122-143
    DOI: 10.1016/j.jebo.2011.10.013
    Contact details of provider: Web page: http://www.elsevier.com/locate/jebo

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    1. Tarun Chordia, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, vol. 56(2), pages 501-530, 04.
    2. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
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    6. Tarun Chordia & Asani Sarkar & Avanidhar Subrahmanyam, 2003. "An empirical analysis of stock and bond market liquidity," Staff Reports 164, Federal Reserve Bank of New York.
    7. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2008. "Liquidity and market efficiency," Journal of Financial Economics, Elsevier, vol. 87(2), pages 249-268, February.
    8. Raffaella Giacomini & Barbara Rossi, 2010. "Forecast comparisons in unstable environments," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(4), pages 595-620.
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