Is the CDS spread still a reliable risk indicator? The impact of the European regulation on uncovered CDS positions on market developments in the Central and Eastern European region

Our article discusses the 2012 European Union regulation on naked CDS positions and its effects on CDS market developments in Central and Eastern European EU Member States. Although following the adoption of the regulation in March, an adjustment period of nearly seven months was available until it became effective, in the emerging European markets a considerable proportion of actors reacted to the changes only relatively late, in the first half of October. The concentrated closing of short CDS positions within a short period of time significantly reduced the CDS spreads of the countries in the region. We examined this direct effect and found that as a result of the regulation itself, both the average regional and the Hungarian CDS spread shifted 50 basis points downwards, with the resulting difference proving to be permanent. This shift makes the comparison of CDS spreads more difficult both in cross-sectional and in time series terms. At the same time, we are of the opinion that the dynamics of CDS spreads may provide good guidance regarding the shifts in individual countries’ risk perception even after the regulation came into force on 1 November.