How Sovereign is Sovereign Credit Risk?

Longstaff, Francis A.; Pan, Jun; Pedersen, Lasse Heje; Singleton, Kenneth J.

doi:10.3386/w13658

Cited by 271 publications

(352 citation statements)

References 78 publications

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“…For example, the mean R 2 for the in-sample (out-of-sample) countries is 63% (61%), while the median R 2 for the in-sample (out-of-sample) countries is 71% (64%). These results are consistent with the conclusion of Pan and Singleton (2008) and Longstaff et al (2011) that the majority of sovereign credit risk can be linked to a common factor. However, the way we model and estimate the common factor is different from that in existing sovereign credit risk models.…”

Section: Nature Of the Common Factorsupporting

confidence: 92%

“…Consistent with Pan and Singleton (2008) and Longstaff et al (2011), our parameter estimates show that θ > θ P and κ < κ P , suggesting that the default intensity has higher mean and is more persistent under the risk-neutral measure. Table 6 reports the standard deviation of the pricing errors at different maturities for the 34 insample countries.…”

Section: Parameter Estimatessupporting

confidence: 78%

“…For example, Pan and Singleton (2008) show that one common principal component (PC) explains more than 90% of the variations of the CDS spreads of three geographically dispersed countries: Mexico, Turkey, and Korea. Longstaff et al (2011) conclude that the CDS spreads of 26 developed and emerging market countries are driven primarily by the VIX index, US equity, and highyield factors. Based on a sovereign credit risk model with a common and a country-specific factor, Ang and Longstaff (2013) show that the US and European systemic factors extracted from the CDS spreads of the US government, 10 individual US states, and 11 EMU sovereigns are highly correlated with one another and are strongly related to financial market variables.…”

Section: Introductionmentioning

confidence: 88%

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A Rating-Based Sovereign Credit Risk Model: Theory and Evidence

Yang

2014

SSRN Journal

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We develop a rating-based continuous-time model of sovereign credit risk with closed-form solutions for a wide range of credit derivatives. In our model, rating transition follows a continuoustime Markov chain, and countries with same credit rating share similar level of default risk. A parsimonious version of our model, with only 16 parameters, one common and one country-specific factor, can simultaneously capture the term structure of CDS spreads of 34 in-sample and 34 outof-sample countries well. On average, the common factor explains more than 60% of the variations of the CDS spreads of both the in-sample and out-of-sample countries, and 80% of the variations of the common factor is explained by the CBOE VIX index, the 5-year US Treasury rate, and the CDX NA IG Index. AbstractWe develop a rating-based continuous-time model of sovereign credit risk with closed-form solutions for a wide range of credit derivatives. In our model, rating transition follows a continuoustime Markov chain, and countries with the same credit rating share a similar level of default risk.A parsimonious version of our model, with only 16 parameters, as well as one common and one country-specific factor, can simultaneously capture the term structure of CDS spreads of 34 insample and 34 out-of-sample countries well. On average, the common factor explains more than 60% of the variations of the CDS spreads of both the in-sample and out-of-sample countries, and 80% of the variations of the common factor is explained by the CBOE VIX index, the 5-year US Treasury rate, and the CDX NA IG Index.

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Section: Nature Of the Common Factorsupporting

confidence: 92%

Section: Parameter Estimatessupporting

confidence: 78%

Section: Introductionmentioning

confidence: 88%

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A Rating-Based Sovereign Credit Risk Model: Theory and Evidence

Yang

2014

SSRN Journal

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“…This is a question of special interest for economists, investors, and financial regulators. Similarly to a number of recent studies, we also monitor the market perception of sovereign risk by using information derived from CDS spreads (Longstaff, Pan, Pedersen, and Singleton, 2011;Bei and Wei, 2012;Ang and Longstaff, 2013). CDS spreads are a more accurate measure to gauge market perceptions of sovereign credit risk than are sovereign bond yield spreads.…”

Section: Introductionmentioning

confidence: 99%

Market perception of sovereign credit risk in the euro area during the financial crisis

Camba-Méndez

Serwa

2016

The North American Journal of Economics and Finance

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractWe study market perception of sovereign credit risk in the euro area during the financial crisis. In our analysis we use a parsimonious CDS pricing model to estimate the probability of default (PD) and the loss given default (LGD) as perceived by financial markets. We find that separate identification of PD and LGD appears empirically tractable for a number of euro area countries. In our empirical results the estimated LGDs perceived by financial markets stay comfortably below 40% in most of the samples. We also find that macroeconomic and institutional developments were only weakly correlated with the market perception of sovereign credit risk, whereas financial contagion appears to have exerted a non-negligible effect.JEL-Classification: C11, C32, G01, G12, G15. Keywords: sovereign credit risk, CDS spreads, euro area, probability of default, loss given default.ECB Working Paper 1710, August 2014 1 Executive summaryThe aim of this paper is to study market perception of sovereign credit risk in the euro area during the financial crisis. Understanding the factors that influence changes in market perception of sovereign credit risk is a question of special interest for economists, investors, and financial regulators. Similarly to a number of recent studies, we also monitor the market perception of sovereign risk by using information derived from CDS spreads.In studying market perceptions of sovereign credit risk, one of the aims of this paper is to estimate measures of the probability of default (PD) as perceived by financial markets and the loss given default (LGD), also as perceived by financial markets, embedded in the CDS spreads. Earlier studies of the euro area sovereign debt crisis usually employed the CDS spreads alone and thus were not able to separately identify changes in the valuation of risk stemming from either increases of potential losses or a growing likelihood of default.Yet, in the pricing framework of 'fractional recovery of face value', the factors governing the dynamics of the PD and LGD play very distinct roles in the derivation of the price of the CDS contract, thus suggesting that PD and LGD can indeed, at least in theory, be separately identified. However, what is conceptually true may not always hold empirically, and to date the separate identification of PD and LGD remains challenging.The second aim of this paper is to shed some light on the key drivers of the market perception of ...

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“…Most existing papers on sovereign CDS deal with emerging markets, which were the birthplace of the sovereign CDS market. For instance, Longstaff, Pan, Pedersen and Singleton (2011) explore the factors driving sovereign CDS, while Pan and Singleton (2008) analyse the term structure of sovereign CDS. What most of these studies have in common is that they do not cover a crisis in sovereign credit markets.…”

Section: Introductionmentioning

confidence: 99%

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

Andenmatten

Brill²

2011

Swiss J Economics Statistics

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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.

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How Sovereign is Sovereign Credit Risk?

Cited by 271 publications

References 78 publications

A Rating-Based Sovereign Credit Risk Model: Theory and Evidence

A Rating-Based Sovereign Credit Risk Model: Theory and Evidence

Market perception of sovereign credit risk in the euro area during the financial crisis

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

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