Who leads the price determination in periods of financial distress: Credit default swaps or bonds spreads? Evidence for a set of EU member States

This paper uses daily data of credit default swaps premiums and sovereign bonds spreads in a set of European Union member States with different sovereign risk levels, to analyze the dynamics of each market in the price discovering process in the aftermath of the financial crisis. Based on the identification of structural changes and cointegration analysis, Autoregressive Distributed Lag Error Correction models are estimated for the sub periods prior and after structural changes and for the 2-years and 5-years maturity segments. The evidence for the high indebted countries, as well as for other European countries perceived as less risky countries, suggests the existence of distinct dynamics for different maturities. In the shorter maturity segment, the sovereign bonds market leads the price determination in the high indebted countries in periods of low distress, but a reversal of the transmission direction effects is observed in these countries in periods of high distress. In the 5-years maturity segment there is a clear dominant role of the credit default swaps markets in defining bonds prices, even in periods of low distress. These results seem to suggest that the increased risk of holding longer-term debt assets motivates the agents to liquidate their positions and to turn to shorter-term positions.