Search results
1 – 10 of 219Samuel Pollege and Peter N. Posch
The sovereign debt crisis in Europe increased the demand for asset manager worldwide to monitor and manage their sovereign risk. While using information from the credit…
Abstract
Purpose
The sovereign debt crisis in Europe increased the demand for asset manager worldwide to monitor and manage their sovereign risk. While using information from the credit derivatives and bond markets has been used widely in the corporate sector its usage for sovereign risk is novel. The paper aims to discuss these issues.
Design/methodology/approach
The basis between a sovereign credit default swap (CDS) and the government bond contains valuable information for assets managers and traders alike. The paper demonstrates the use of the basis between the announcement date and the issue date of a new government bond to decide whether an investment in this bond is profitable.
Findings
With this strategy, the authors are able to generate both over all excess returns with a European sovereign portfolio since 2008 as well as a constant outperformance of simple average euro government bond portfolios. The paper furthermore tests the economic rationale behind this trading strategy and confirms prior findings from the corporate market. CDS market liquidity is among the main driver and it follows that the CDS market is faster in anticipating risks than the bond market not only for corporate but also for sovereign entities.
Originality/value
The authors are the first to study the sovereign basis in a sound trading and asset management environment. The paper provides economic explanations and checks for the robustness of the results before the primary issuance of a new government bond.
Details
Keywords
This chapter provides a comprehensive overview of the young, but rapidly growing sovereign credit default swap (CDS) market, describes the function, trading, history, market…
Abstract
This chapter provides a comprehensive overview of the young, but rapidly growing sovereign credit default swap (CDS) market, describes the function, trading, history, market participants, key statistical and stylized facts about CDS prices, determinants, price discovery, and risk issues.
Details
Keywords
Christina E. Bannier, Thomas Heidorn and Heinz-Dieter Vogel
This paper aims to provide an overview of the market for corporate and sovereign credit default swaps (CDS), with particular focus on Europe. It studies whether the subprime…
Abstract
Purpose
This paper aims to provide an overview of the market for corporate and sovereign credit default swaps (CDS), with particular focus on Europe. It studies whether the subprime crisis of 2007/2008 and, particularly, the European debt crisis 2009/2010 led to a differential development on corporate and sovereign CDS markets and investigates the primary use (speculative risk-trading or risk-hedging) of the two markets in recent years.
Design/methodology/approach
The authors use aggregate market data on the size of the respective markets and on the structure of market participants and their changes over time to assess the main research question. They enhance existing data from public sources such as the Bank for International Settlements and Depository Trust and Clearing Corporation with their own statistics on European sovereign CDS and combine their conclusions with observations regarding standardisation efforts and regulatory changes in the CDS market.
Findings
The authors show that after the subprime crisis 2007/2008 and the European debt crisis 2009/2010, the corporate and sovereign CDS markets developed quite differently. They provide evidence that since mid-2010, market participants started to use the sovereign CDS market more strongly for speculative purposes than for risk-hedging. This shows both in the shift of risk-quality of sovereign CDS contracts and in the changing structure of market participants. The ongoing standardisation and regulation in the CDS market – leading to further increases in transparency and reductions in transaction costs – may be expected to trigger a similar change also for corporate CDS.
Originality/value
Based on a broad variety of market infrastructure data, the authors show a diverging development of corporate and sovereign CDS markets in Europe in recent years. Particularly the sovereign CDS market appears to have shifted from a risk-hedging instrument to being used more strongly for speculative risk-trading. The authors combine their findings with recent regulatory action and market standardisation schemes and draw conclusions for the future development of CDS markets.
Details
Keywords
Yan Alice Xie, Jot Yau and Hei Wai Lee
The study examines the joint effect of sovereign and call risks on the duration of callable sovereign bonds over the period 1996–2011. The results indicate that the sovereign…
Abstract
The study examines the joint effect of sovereign and call risks on the duration of callable sovereign bonds over the period 1996–2011. The results indicate that the sovereign risk-adjusted duration is significantly shorter than its Macaulay counterpart for U.S. dollar-denominated investment-grade callable sovereign bonds. Further, the “shortening” effect of sovereign and call risks on duration is generally stronger among bonds of lower ratings. Similar results are obtained when CDS prices are used as a proxy for changes in sovereign risk. Results from this study emphasize the importance of considering the joint effect of sovereign and call risks in managing the interest rate risk exposure in fixed income investments.
Details
Keywords
Saker Sabkha, Christian de Peretti and Dorra Mezzez Hmaied
The purpose of this paper is to study the volatility spillover among 33 worldwide sovereign Credit Default Swap (CDS) markets and their underlying bond markets.
Abstract
Purpose
The purpose of this paper is to study the volatility spillover among 33 worldwide sovereign Credit Default Swap (CDS) markets and their underlying bond markets.
Design/methodology/approach
In contrast to prior studies, the authors incorporate heteroscedasticity, asymmetric leverage effects and long-memory features of sovereign credit spreads simultaneously through a bivariate FIEGARCH model and a Bayesian cointegrated vector autoregressive model.
Findings
Similar to the literature, the findings confirm that strong evidence of credit risk spillover between credit markets is accentuated during two recent crisis periods. However, the country-by-country analysis indicates that countries exhibit different sensitivity levels and divergent reactions to financial shocks. Further, the authors show that the bidirectional interrelationship evolves over time and across countries emphasizing the necessity of time-varying national regulatory policies and trading positions.
Originality/value
Based on a large data set that covers the recent two financial crises and using complex methods, the work focuses on sovereign tensions that have repercussions on banks’ solvency and refinancing conditions. Yet, the study is a hot topic since that during crisis periods in the financial markets, direct and indirect interconnections increase between sovereign risk and banking risk. Using new econometric approaches, the results show that each country exhibits a different behavior toward the credit risk which is relevant to both portfolio managers and policy makers. The time-varying spillover effects detected between markets are an accurate indicator of financial stability, allowing policy makers to put in place personalized economic policies. On the other hand, markets’ participants could take advantages of the results by adjusting their trading and hedging positions on the dynamic co-movements. The findings reveal, as well, that the sovereign crisis has more weakened the global financial and banking system than the subprime crisis. The authors previously tackled the cross-country contagion phenomenon in the CDS markets, and this manuscript builds on the prior study to enhance the obtained results.
Details
Keywords
Kam C. Chan, Hung‐Gay Fung and Gaiyan Zhang
When extended to sovereign issuers, the Merton‐type structural model suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices. In…
Abstract
When extended to sovereign issuers, the Merton‐type structural model suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices. In practice, capital structure arbitrage that exploits such relationships should foster the integration of CDS and the stock market and improve price discovery. This paper studies the dynamic relationship between sovereign CDS spreads and stock prices for seven Asian countries for the period from January 2001 to February 2007. We find a strong negative correlation between the CDS spread and the stock index for most Asian countries. A long‐run equilibrium price relationship is found for China, Korea, and Thailand. The limited integration in other countries may arise from market frictions and model applicability. In terms of price discovery, CDS markets play a leading role in five out of seven countries. Therefore, equity investors should span the CDS market for incremental information. The stock market has a feedback effect for two countries and dominates price discovery for only one country.
Details
Keywords
Florian Kiesel, Felix Lücke and Dirk Schiereck
This study aims to analyze the impact and effectiveness of the regulation on the European sovereign Credit Default Swap (CDS) market. The European sovereign debt crisis has drawn…
Abstract
Purpose
This study aims to analyze the impact and effectiveness of the regulation on the European sovereign Credit Default Swap (CDS) market. The European sovereign debt crisis has drawn considerable attention to the CDS market. CDS have the ability of a speculative instrument to bet against a sovereign default. Therefore, the Regulation (EU) No. 236/2012 was introduced as the worldwide first uncovered CDS regulation. It prohibits buying uncovered sovereign CDS contracts in the European Union (EU).
Design/methodology/approach
First, this paper measures spread changes of sovereign CDS of the EU member states around regulation specific event dates to detect whether and when European sovereign CDS reacts to regulation announcements and the enforcement of regulation. Second, it compares the CDS long-term stability of the EU sample with a non-EU sample based on 44 non-EU sovereign CDS entities.
Findings
The results indicate widening CDS spreads prior to the regulation, and stable CDS spreads following the introduction of the regulation. In particular, sovereign CDS of European crisis-hit entities are stable since the regulation was introduced.
Originality/value
The results show that since the regulation of uncovered CDS in the EU has been enacted, the sovereign CDS market is stable and less volatile. Based on the theory about speculation on uncovered sovereign CDS by betting on the reference entity’s default, the introduction of Regulation (EU) No. 236/2012 appears to be an appropriate measure to stabilize markets and reduce speculation on sovereign defaults.
Details
Keywords
Rick van de Ven, Shaunak Dabadghao and Arun Chockalingam
The credit ratings issued by the Big 3 ratings agencies are inaccurate and slow to respond to market changes. This paper aims to develop a rigorous, transparent and robust credit…
Abstract
Purpose
The credit ratings issued by the Big 3 ratings agencies are inaccurate and slow to respond to market changes. This paper aims to develop a rigorous, transparent and robust credit assessment and rating scheme for sovereigns.
Design/methodology/approach
This paper develops a regression-based model using credit default swap (CDS) data, and data on financial and macroeconomic variables to estimate sovereign CDS spreads. Using these spreads, the default probabilities of sovereigns can be estimated. The new ratings scheme is then used in conjunction with these default probabilities to assign credit ratings to sovereigns.
Findings
The developed model accurately estimates CDS spreads (based on RMSE values). Credit ratings issued retrospectively using the new scheme reflect reality better.
Research limitations/implications
This paper reveals that both macroeconomic and financial factors affect both systemic and idiosyncratic risks for sovereigns.
Practical implications
The developed credit assessment and ratings scheme can be used to evaluate the creditworthiness of sovereigns and subsequently assign robust credit ratings.
Social implications
The transparency and rigor of the new scheme will result in better and trustworthy indications of a sovereign’s financial health. Investors and monetary authorities can make better informed decisions. The episodes that occurred during the debt crisis could be avoided.
Originality/value
This paper uses both financial and macroeconomic data to estimate CDS spreads and demonstrates that both financial and macroeconomic factors affect sovereign systemic and idiosyncratic risk. The proposed credit assessment and ratings schemes could supplement or potentially replace the credit ratings issued by the Big 3 ratings agencies.
Details
Keywords
The recent development of the European debt sovereign crisis showed that sovereign debt is not “risk free.” The traditional index bond management used during the last two decades…
Abstract
Introduction
The recent development of the European debt sovereign crisis showed that sovereign debt is not “risk free.” The traditional index bond management used during the last two decades such as the market-capitalization weighting scheme has been severely called into question. In order to overcome these drawbacks, alternative weighting schemes have recently prompted attention, both from academic researchers and from market practitioners. One of the key developments was the introduction of passive funds using economic fundamental indicators.
Purpose
In this chapter, the authors introduced models with economic drivers with an aim of investigating whether the fundamental approaches outperformed the other models on risk-adjusted returns and on other terms.
Methodology
The authors did this by constructing five portfolios composed of the Eurozone sovereigns bonds. The models are the Market-Capitalization RP, GDP model RP, Ratings RP model, Fundamental-Ranking RP, and Fundamental-Weighted RP models. These models were created exclusively for this chapter. Both Fundamental models are using a range of 10 country fundamentals. A variation from other studies is that this dissertation applied the risk parity concept which is an allocation technique that aims to equalize risk across different assets. This concept has been applied by assuming the credit default swap as proxy for sovereign credit risk. The models were run using the Generalized Reduced Gradient (GRG) method as the optimization model, together with the Lagrange Multipliers as techniques and the Karush–Kuhn–Tucker conditions. This led to the comparison of all the models mentioned above in terms of performance, risk-adjusted returns, concentration, and weighted average ratings.
Findings
By analyzing the whole period between 2006 and 2014, it was found that both the fundamental models gave very appealing results in terms of risk-adjusted returns. The best results were returned by the Fundamental-Ranking RP model followed by the Fundamental-Weighting RP model. However, better results for the mixed performance and risk-adjusted returns were achieved on a yearly basis and when sub-dividing the whole period in three equal periods. Moreover, the authors concluded that over the long term, the fundamental bond indexing triumphed over the other approaches by offering superior return and risk characteristics. Thus, one can use the fundamental indexation as an alternative to other traditional models.
Details
Keywords
The paper examines the impact of the deteriorating fiscal conditions of Eurozone countries on spillover effects on bank credit margins. It is investigated whether these effects…
Abstract
Purpose
The paper examines the impact of the deteriorating fiscal conditions of Eurozone countries on spillover effects on bank credit margins. It is investigated whether these effects have been reduced after European Central Bank’s (ECB) signaling of pursuing an expansionary, unconventional, monetary policy to address the debt crisis in Eurozone.
Design/methodology/approach
A general econometric panel model is applied to investigate spillover effects between Eurozone countries and bank credit margins. In total, three periods are examined: the period before the peak of the global financial crisis and the beginning of the Irish banking crisis, the period during the debt and bank crisis in Eurozone and the period after ECB's signaling of extremely aggressive monetary easing.
Findings
According to empirical results, before the peak of the global financial crisis there was no substantial credit risk transfer from Eurozone sovereigns to banks. During the period of debt and bank crisis in Eurozone, the deterioration of the fiscal situation of Eurozone countries had a significant impact on bank Credit Default Swap (CDS) spreads. After ECB's signaling of extremely aggressive monetary easing, it does not seem to be any significant relationship between Eurozone sovereigns and bank CDS spreads. These findings reinforce the assessment that ECB's measures were effective, achieving the key objective of normalizing economic conditions and ensuring financial stability in Eurozone.
Research limitations/implications
A question is whether effects can change when the corresponding contraction will lead to a reinstatement of “normal” conditions. Would there be a reversal of risk premium trends in bond markets? Although the answer from casual observations seems to be negative, it is a valid research question to be examined. An interesting issue concerning the unconventional monetary policy measures implemented by ECB concerns the issues of moral hazard that they incorporate, something that could not be addressed. Another research perspective could be the use of the beta coefficient to measure the systematic and unsystematic risk of banking sector shares.
Practical implications
The results have strong implications for ECB and European banking regulation. Regulators should mainly pay more attention to the amount and concentration of sovereign debt held by banks. Eurozone financial system could be less vulnerable to the sovereign credit risk. It raised the critical question of whether a more strict regulation is needed. Regulators should not intervene if not necessary, but they must prevent the transmission of crises between markets. This will likely bring trust to the developed countries' sovereign debt and the portfolios of the financial institutions, which hold most of this debt will be considered safe as well.
Social implications
The conclusions provide a safe counterweight in various respects. First, the negative effects and the need to rapidly cease or limit such policies. Second, the financial stability aimed by ECB. Such policies contain the possibility of a subsequent moral hazard related to Member State and bank behavior. However, these contingencies need to be assessed with the benefits resulting from the restoration of financial markets and the disconnection between banking and sovereign credit risk. This leads Eurozone's financial system to become less vulnerable to the sovereign credit risk and therefore more safe, helping to restore confidence in the real economy.
Originality/value
Contribution in terms of methodology and conclusions. It offers important conclusions regarding the limitations of yields and volatility of CDS spreads. It examines the spillover effects of the fiscal situation of Eurozone countries on banking institutions by extending the existing methodology and introducing new questions focusing on the reaction of CDS market to the ECB monetary policy, the reduction of risk premiums at sovereign and banking level and the gradual reduction of interdependence between them.
Details