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Nonlinearities in sovereign risk pricing the role of cds index contracts

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  • Anne Laure Delatte

    (Ofce sciences-po, Cnrs,Cepr
    Neoma Business school, CGEMP LEDa Author-Name : Richard Portes
    London Business School, CEPR)

Abstract

Is the pricing of sovereign risk linear during bearish episodes? Or can initial shocks on economic fundamentals be exacerbated by endogenous factors that create nonlinearities? We test for nonlinearities in the sovereign bond market of European peripheral countries during the debt crisis and explain them. Our estimates based on a panel smooth threshold regression model during January 2006 to September 2012 show four main findings: 1)Peripheral sovereign spreads are subject to significant nonlinear dynamics. 2) he deterioration of market conditions for financial names changes the way investors price risk of the sovereigns. 3)The spreads of European peripheral countries have been priced above their historical values, given fundamentals, because of amplification effects. 4)Two CDS indices on financial names unambiguously stand out as leading drivers of these amplification effects.

Suggested Citation

  • Anne Laure Delatte, 2014. "Nonlinearities in sovereign risk pricing the role of cds index contracts," Documents de Travail de l'OFCE 2014-08, Observatoire Francais des Conjonctures Economiques (OFCE).
  • Handle: RePEc:fce:doctra:1408
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    More about this item

    Keywords

    European sovereign crisis; Panel Smooth Threshold regression models; CDS indices;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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