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Credit-Risk Valuation in the Sovereign CDS and Bonds Markets: Evidence from the Euro Area Crisis

Author

Listed:
  • Óscar Arce

    () (Directorate General Economics, Statistics and Research, Bank of Spain)

  • Sergio Mayordomo

    () (School of Economics and Business Administration, University of Navarra)

  • Juan Ignacio Peña

    () (Department of Business Administration, Universidad Carlos III de Madrid)

Abstract

We analyse the extent to which prices in the sovereign credit default swap (CDS) and bond markets reflect the same information on credit risk in the context of the current crisis of the European Monetary Union (EMU). We first document that deviations between CDS and bond spreads are related to counterparty risk, common volatility in EMU equity markets, market illiquidity, funding costs, flight-to-quality, and the volume of debt purchases by the European Central Bank (ECB) in the secondary market. Based on this we conduct a state-dependent price-discovery analysis that reveals that the levels of the counterparty risk and the common volatility in EMU equity markets, and the banks agreements to accept losses on their holdings of Greek bonds impair the ability of the CDS market to lead the price discovery process. On the other hand, the funding costs, the flight-to-quality indicator and the volume of debt purchases by the ECB worsen the efficiency of the bond market.

Suggested Citation

  • Óscar Arce & Sergio Mayordomo & Juan Ignacio Peña, 2012. "Credit-Risk Valuation in the Sovereign CDS and Bonds Markets: Evidence from the Euro Area Crisis," Faculty Working Papers 22/12, School of Economics and Business Administration, University of Navarra.
  • Handle: RePEc:una:unccee:wp2212
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    sovereign credit default swaps; sovereign bonds; credit spreads; price discovery;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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