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Pricing of Sovereign Credit Risk; Evidence From Advanced Economies During the Financial Crisis

  • C. Emre Alper
  • Lorenzo Forni
  • Marc Gerard

We investigate the pricing of sovereign credit risk over the period 2008-2010 for selected advanced economies by examining two widely-used indicators: sovereign credit default swap (CDS) and relative asset swap (RAS) spreads. Cointegration analysis suggests the existence of an imperfect market arbitrage relationship between the cash (RAS) and the derivatives (CDS) markets, with price discovery taking place in the latter. Likewise, panel regressions aimed at uncovering the fundamental drivers of the two indicators show that the CDS market, although less liquid, has provided a better signal for sovereign credit risk during the period of the recent financial crisis.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/24.

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Length: 27
Date of creation: 01 Jan 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/24
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  1. Virginie Coudert & Mathieu Gex, 2011. "The Interactions Between the Credit Default Swap and the Bond Markets in Financial Turmoil," Working Papers 2011-02, CEPII research center.
  2. Edwards, Sebastian, 1984. "LDC Foreign Borrowing and Default Risk: An Empirical Investigation, 1976-80," American Economic Review, American Economic Association, vol. 74(4), pages 726-34, September.
  3. Christopher J. Neely, 2010. "The large scale asset purchases had large international effects," Working Papers 2010-018, Federal Reserve Bank of St. Louis.
  4. Eric M. Engen & R. Glenn Hubbard, 2004. "Federal Government Debt and Interest Rates," NBER Working Papers 10681, National Bureau of Economic Research, Inc.
  5. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2011. "Large-scale asset purchases by the Federal Reserve: did they work?," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 41-59.
  6. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2005. "An Empirical Analysis of the Dynamic Relation between Investment-Grade Bonds and Credit Default Swaps," Journal of Finance, American Finance Association, vol. 60(5), pages 2255-2281, October.
  7. Norden, Lars & Weber, Martin, 2004. "The Comovement of Credit Default Swap, Bond and Stock Markets: An Empirical Analysis," CEPR Discussion Papers 4674, C.E.P.R. Discussion Papers.
  8. R. Glenn Hubbard & Eric M. Engen, 2004. "Federal Government Debt and Interest Rates," Working Papers 50018, American Enterprise Institute.
  9. Fontana, Alessandro & Scheicher, Martin, 2010. "An analysis of euro area sovereign CDS and their relation with government bonds," Working Paper Series 1271, European Central Bank.
  10. Edda Zoli & Silvia Sgherri, 2009. "Euro Area Sovereign Risk During the Crisis," IMF Working Papers 09/222, International Monetary Fund.
  11. Miguel A. Segoviano Basurto & Carlos Caceres & Vincenzo Guzzo, 2010. "Sovereign Spreads; Global Risk Aversion, Contagion or Fundamentals?," IMF Working Papers 10/120, International Monetary Fund.
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