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Spillovers of the Credit Default Swap Market

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  • Mauricio Calani C.

Abstract

Credit Default Swap (CDS) prices have soared on the edge of a potential sovereign default of some European countries. Interestingly, not only countries on the verge of receiving bailouts have seen their CDS prices rise, but also those from which most of the bailout financing would come, such as Germany. If in fact default probabilities of countries like Germany have risen, should we still view them as safe-havens? In particular, to what extent should we see bond yields rise (as bond prices decline) vis-a-vis CDS spreads? This paper tackles this question by estimating the dynamic responses of bond yields to changes in the CDS spreads. The second, more fundamental question is to assess if the apparent contagion from troubled countries to otherwise-healthy economies is in fact so. I address this question using the Diebold - Yilmaz spillover index methodology for CDS data. I conclude that sovereign debt from Germany, Chile and Japan are unaffected by contagion from other economies and have served as safe-haven assets during the current financial distress episode.

Suggested Citation

  • Mauricio Calani C., 2012. "Spillovers of the Credit Default Swap Market," Working Papers Central Bank of Chile 678, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:678
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    References listed on IDEAS

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    1. FrancisX. Diebold & Kamil Yilmaz, 2009. "Measuring Financial Asset Return and Volatility Spillovers, with Application to Global Equity Markets," Economic Journal, Royal Economic Society, vol. 119(534), pages 158-171, January.
    2. Rodrigo A. Alfaro & Rodrigo Cifuentes S., 2011. "Financial Stability, Monetary Policy, and Central Banking: An Overview," Central Banking, Analysis, and Economic Policies Book Series,in: Rodrigo Alfaro (ed.), Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 1, pages 001-010 Central Bank of Chile.
    3. Garman, Mark B & Klass, Michael J, 1980. "On the Estimation of Security Price Volatilities from Historical Data," The Journal of Business, University of Chicago Press, vol. 53(1), pages 67-78, January.
    4. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    5. Pesaran, H. Hashem & Shin, Yongcheol, 1998. "Generalized impulse response analysis in linear multivariate models," Economics Letters, Elsevier, vol. 58(1), pages 17-29, January.
    6. Francis X. Diebold & Kamil Yilmaz, 2011. "Equity Market Spillovers in the Americas," Central Banking, Analysis, and Economic Policies Book Series,in: Rodrigo Alfaro (ed.), Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 7, pages 199-214 Central Bank of Chile.
    7. Nicolás Álvarez H. & Luis Opazo R., 2009. "Paridad Cubierta de Tasas de Interés de Largo Plazo en Chile," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 12(2), pages 67-95, August.
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    Cited by:

    1. Michał Adam, 2013. "Spillovers and contagion in the sovereign CDS market," Bank i Kredyt, Narodowy Bank Polski, vol. 44(6), pages 571-604.

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