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

Abstract

This paper employs the multivariate VAR model to examine the mechanic work of price discovery process between sovereign CDS market and the associated sovereign bond market in contexts of five European and Asian countries, including Vietnam, Korea, Portugal, Italy and France from the beginning of 2008 to the end of April, 2017. The study accentuates on three aspects: the short-term interaction nexus between the sovereign CDS and the associated-sovereign bond market, the long-term co-movement between them and the discovery of which market plays the leading role in the pricing process. The results evidence the short-run and long-run relationship for the two markets. Particularly, the empirical test results support for the predominant role of the sovereign CDS market in the price discovery process in the bulk of sample entities. This might suggests for the governments to use CDS prices as the future indicator for predicting the volatility of debt markets.

The Interactions and Trade-Offs of Sovereign Credit Default Swap (Cds) and Bond Spreads in a Dynamic Context

“…They also find that the CDS market dominates the information transmission between CDS and bond markets in periods of financial distress. Similar results are provided by the study of Nguyen (2017), which focuses on the global crisis period and beyond (2008)(2009)(2010)(2011)(2012)(2013)(2014)(2015)(2016)(2017), analyzing a sample of three European and two Asian countries.…”

“…Similarly, this is the first study that investigates the relationship between CDS and bond spreads for the indebted countries of south Europe in comparison to other Eurozone countries with more advanced credit markets over an extended period including the latest episodes of the European sovereign crisis. Prior studies analyze heterogeneous samples in terms of geographical area (Nguyen, 2017), focus on the Southern European countries (Delis & Mylonidis, 2011), or examine large samples of European countries until the peak of the crisis (Delatte et al, 2012;Arce et al, 2013). The examination of the relationship between sovereign CDS and bond markets of peripheral along with core European countries over a ten-year period is expected to lead to robust findings with regard to the evolution of CDS and bond price dynamics in the euro area.…”

“…CDS and bond spreads, particularly in the heavily indebted Eurozone countries, increased substantially and so did the trading activity in the CDS market. As a result, a new stream of literature emerged, focusing on the price discovery process in sovereign credit markets of developed countries with the intention of detecting whether rises in CDS spreads can trigger rises in bond spreads (Group of 20, 2009;Palladini & Portes, 2011;Delatte, Gex, & López-Villavicencio, 2012;Coudert & Gex, 2013;Andraz, Viegas, & Norte, 2015;Fontana & Scheicher, 2016;Ito, 2016;Nguyen, 2017). Nevertheless, just as in the case of developing countries, these studies have failed to provide converging findings.…”