Did the CDS market push up risk premia for sovereign credit?

Abstract

Summary We examine the empirical relationship between credit default swap (CDS) premia and government bond spreads for Portugal, Italy, Ireland, Greece, and Spain (the ‘PIIGS’ countries). We find some evidence for a long-run relationship in the sense of cointegration for the two markets. In most cases (five out of seven), only CDS premia contribute to the price discovery process. In the other cases, both markets make a more or less equal contribution. All in all, this suggests that bond spreads react only sluggishly to long-term imbalances, as measured by the cointegrating relationship. In light of this, we can conclude that, in most cases, CDS markets are leading markets if there is a long-run relationship between the CDS and government bond spread markets. This may partly be due to liquidity effects.

The Price Discovery Mechanism between Sovereign Bond and Sovereign CDS Market: Studies in Selected Countries

“…For example, the Granger tests in Andenmatten, S. and Brill, F. (2010) rely on 4-day lags for Portugal, 3-day lags for Italy and 2-day lags for the rest of sovereign markets.…”

“…Augustin, P. and Tedongap, R. (2011) neutrally state that either catastrophic CDS market or bond market could engage the negative effect on the financial stability. Stulz, R. (2010); Andenmatten, S. and Brill, F. (2010) opposingly conclude the smaller role of CDS market in the financial sovereign crisis compared to bond market due to its relatively small market size. The paper, in the other way round, is to demonstrate the assertions of those above to be appropriate depend on case of low-yield or high-yield sovereigns.…”

The Role of CDS Market in the Price Discovery Process of the “PIIGS” Countries Sovereign Credit Risk During the Recent Decade of Monetary Easing

“…Focusing on the Euro Area countries over the period 2004-2011, they prove that the CDS market leads the bond market in the price discovery process of credit risk. Andenmatten et al (2011) examine the empirical relationship between CDS premia and government bond spreads for Portugal, Italy, Ireland, Greece, and Spain (the "PIIGS" countries) for the period from January 2007 to April 2010. They conclude that, in most cases (five out of seven), only CDS premia contribute to the price discovery process during the analyzed period.…”