Market frictions and the pricing of sovereign credit default swaps

Abstract

This paper contributes to the general understanding of how sovereign CDS prices are formed by studying the information content of pricing errors generated by a non-arbitrage model. We implement a price-discrepancy measure in the spirit of the noise measure in- suggests that exits of capital arbitrage during distressed periods, as measured by changes in net offsetting, can be associated to larger pricing errors in sovereign CDS from advanced economies, thereby supporting the main claims of the limit-to-arbitrage theories. These findings are robust for the most common CDS pricing models employed in the industry and different estimation techniques.

Dissecting interbank risk using basis swap spreads

“…Our results can be summarised as follows: (a) aggregate liquidity is relevant in explaining the deviations of market prices from fundamental values during periods of financial distress. This pattern accords with the recent literature on market frictions in fixed-income markets; see, for instance, Hu, Pan, and Wang (2013) and Rubia, Sanchis-Marco, and Serrano (2016). A further analysis based on a vector autoregressive (VAR) model shows that the response of interbank risk to liquidity shocks remains statistically significant for 6 weeks; (b) risk aversion, a market-wide measure of uncertainty, also plays a significant role in explaining fluctuations of the expected components; (c) we also observe that unexpected components are clearly linked to systemic risk.…”

Quantifying sovereign risk in the euro area

“…They also show how the main source of risk changes over time: in 2009, it was the global factor, in 2010 the peripheral factor, and finally in 2012 the EA common factor. Finally, Aizenman et al (2013) and Rubia et al (2016) agree that if sovereign CDS s are wrongly assumed to solely reflect default risk, the severity of the underlying market conditions may be substantially overestimated, particularly during periods of distress. Specifically, according to Rubia et al (2016) the case of peripheral EA countries in the midst of the debt crisis might illustrate this point accurately, since sovereign CDS contracts were traded at prices that were too high to reflect solely the credit default risk premium.…”

Relación dinámica entre los Credit Default Swaps y la deuda pública. Análisis en el contexto latinoamericano

“…Adicionalmente, Rubia et al (2016) analizan un conjunto de datos de spreads de bonos de deuda pública del G-20, por medio de regresiones determinantes y predictivas, usando un modelo de intensidad cuadrática sugerido por Houweling y Vorst (2005) y el modelo de Nelson y Siegel, 1987). De dicho análisis se deduce que, por un lado, existe una conexión empírica con los factores de mercado de amplia iliquidez y la valuación incorrecta de los CDS sobre deuda pública y, por otro, se dan diferencias entre el valor teórico y el valor de mercado del CDS, las cuales no solo pueden darse por errores en su apreciación, sino también por fricciones del mercado donde la volatilidad incrementa la asimetría informacional y puede generar pérdidas a la hora de deshacer posiciones.…”