The recent financial crisis offered an interesting opportunity to analyze the markets’ behavior in a high-volatility framework. In this paper, we analyzed the price discovery process of the Italian banks’ Credit Default Swap (CDS) spreads through the Merton model, extended with the inclusion of a redenomination risk proxy, as to say, the risk that Italy could leave the eurozone. This paper contributes to the literature by integrating the classic Merton model with a political-sensitive market variable able to explain the greatest variance in the Italian banks’ CDS spreads during the most relevant and commonly recognized periods of socio-political and financial distress. Results show that the redenomination risk is progressively becoming the main driver of the process during crises, in particular for the sovereign debt crisis and in 2018.

This work analyzes the possible links between CDS premiums and bond spreads, with reference to both Eurozone sovereign and corporate markets, within the period 2011-2018. The main goal of this work is to provide more up-to-date results about the theoretical equivalence between the CDS premium and the credit spread of the underlying bond, and about the price discovery process of the credit risk between the CDS market and the bond market. While, theoretically, the CDS-bond basis must tend to zero, the analysis on all the considered markets has shown that it results to be constantly away from parity and, more specifically, positive on average. The analysis of the price discovery process of the credit risk between the CDS market and the bond market, analyzed by means of the VAR and VECM models, confirms the leader role of bond spreads for almost all the analyzed entities. These evidence could be useful for arbitrageurs, who want to take advantage of potential market inefficiencies, and for regulators interested in guaranteeing the financial system stability through timely and correct inclusion of all available information in the security prices, avoiding any adverse selection issue.

Hedging and speculative strategies play a key role in periods of financial market volatility particularly during economic crises. In such contexts, liquidity problems tend to evolve into potential credit risk events that amplifies the volatility of several markets such as the CDS and the government bond markets. The former, however, generally embodies a higher sensitivity to volatility due to the operators’ uncertainty about unstable and countercyclical counterparty risk. The aim of this paper is to analyze the long-lasting dynamic relationship between credit default swap (CDS) premia and government bond yield spreads (GBS), by focusing particularly on sovereign credit risk, in order to evaluate the lead-lag markets in the price discovery process against the backdrop of a deep financial crisis. The focus of this study concerns the country of Italy, one of the major European countries that suffers from both weak GDP growth and high public debt, which subjects it to volatility and speculation during periods of financial stress. JEL classification numbers: G01, G12, G14, G20. Keywords: CDS spreads, Government bond spreads, Credit risk, Cointegration, Vector error correction model, Granger-causality.

No abstract

The aim of this paper is to analyze the long-lasting dynamic relationship between the credit default swap (CDS) premia and the government bond spreads (GBS), with regard to the sovereign credit risk. The practical focus is to evaluate whether the CDS market effectively is the leading or the lagging market in the credit risk price discovery process during the last decade of monetary easing. The analysis extends to all “sensitive” countries in the Eurozone, the so-called “PIIGS” countries (excluded Greece) for the interval 2007-2017. JEL classification numbers: G01, G12, G14, G20. Keywords: CDS spread, Government bond spread, Sovereign credit risk, Cointegration, Vector error correction model, Granger-causality.