Economic and Financial Determinants of Credit Risk Premiums in the Sovereign CDS Market*

Abstract

We specify and estimate no-arbitrage models for sovereign CDS contracts by assuming that the country's default intensity depends on observable economic and …nancial indicators. We estimate these models using a sample of twenty-eight countries, three CDS maturities, and over a decade of daily data. The models provide a good …t. The impact of the economic and …nancial variables on spreads is consistent with economic intuition. Spreads increase as a function of stock market and exchange rate volatility, but decrease as a function of interest rates and stock market returns. The magnitudes of these impacts vary substantially across countries and over time. Estimated risk premiums are also highly time-varying and peak during the 2008 …nancial crisis for nearly all countries. For European countries, the risk premiums are also high during the Eurozone debt crisis. In periods of market stress and high CDS spreads, the increase in market risk premiums is even larger than the increase in default probabilities. The cross-sectional variation in risk premiums across countries is high, also in non-crisis periods.

Sovereign credit risk and exchange rates: Evidence from CDS quanto spreads

“…Duffie, Pedersen, and Singleton (2003), Hoerdahl and Tristani (2012), and Monfort and Renne (2013) study sovereign credit spreads. With respect to the valuation of sovereign CDS, the early affine term structure models focus on country-by-country estimations such as Turkey, Brazil, Mexico (Pan and Singleton, 2008), and Argentina (Zhang, 2008), or on a panel of emerging (Longstaff, Pan, Pedersen, and Singleton, 2011), or developed and emerging countries (Doshi, Jacobs, and Zurita, 2017). Ang and Longstaff (2013) extract a common systemic factor across Europe and the U.S. using sovereign CDS written on European countries and U.S. states, while Ait-Sahalia, Laeven, and Pelizzon (2014) study pairwise contagion among pairs of seven European countries during the sovereign debt crisis.…”

Regime Switching Determinants of Sovereign CDS Spreads: Evidence From Turkey

“…In this regard, the sovereign CDS contract yields are rather preferred to count for the overall credit worthiness for the credit market in Turkey. Besides, in explaining sovereign CDS spreads, it is not straightforward to give identifying parsimonious sets of variables that are main candidates which are to a large extent provided for corporate CDS contracts (Doshi et al 2014). In this study, the primary attempt is to reveal regime dependent determinants of the sovereign CDS spreads for Turkey.…”

Sovereign Credit Risk and Exchange Rates: Evidence from CDS Quanto Spreads

“…Duffie, Pedersen, and Singleton (2003), Hoerdahl and Tristani (2012), and Monfort and Renne (2013) study sovereign credit spreads. With respect to the valuation of sovereign CDS, the early affine term structure models focus on country-by-country estimations such as Turkey, Brazil, Mexico (Pan and Singleton, 2008), and Argentina (Zhang, 2008), or on a panel of emerging (Longstaff, Pan, Pedersen, and Singleton, 2011), or developed and emerging countries (Doshi, Jacobs, and Zurita, 2017). Ang and Longstaff (2013) extract a common systemic factor across Europe and the U.S. using sovereign CDS written on European countries and U.S. states, while Ait-Sahalia, Laeven, and Pelizzon (2014) study pairwise contagion among pairs of seven European countries during the sovereign debt crisis.…”