No. 821 - The sovereign credit default swap market: price discovery, volumes and links with banks’ risk premia

This paper looks into the sovereign credit default swap (CDS) market from two perspectives. First, it analyses the relation between CDS and bond spreads. The results on a single-entity basis suggest that the CDS market leads the bond market in price discovery, especially during 2010, while both markets contribute during the pre-Lehman period and in 2009. Moreover, the inclusion of the EURIBOR-EUREPO 3-month spread helps to restore the long-run relation after the Lehman bailout. An event-study, which compares the reaction of sovereign CDS and bond markets to policy announcements in Europe, suggests that both markets react in the same way, especially after the release of bad news. As for the relation between prices and volumes of sovereign CDSs, estimates do not point to any stable relation. The second perspective is the relation between CDS spreads for sovereign and corporate entities. Our estimates on an aggregate and sector-wide basis point to a leading property of the former sector, even in 2009, while the banking sector increases its leading power during 2010.