Regime-dependent determinants of Euro area sovereign CDS spreads

H.J. Blommestein, Sylvester Eijffinger, Zongxin Qian

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We study the determinants of sovereign CDS spreads of five Euro area countries (Greece, Ireland, Italy, Portugal, and Spain) after the collapse of Lehman Brothers. We find that global and/or European Monetary Union (EMU)-wide factors are the main drivers of changes in the sovereign CDS spreads in our sample. However, the impacts of those factors change with market uncertainty. There is a relatively tranquil regime where market uncertainty is low and a relatively turbulent regime where market uncertainty is high. The transition from the tranquil regime to the turbulent regime is driven by changes in the global jump risk, which suggests that contagion from the global financial market significantly affected the pricing of sovereign credit risk in our sample. Domestic economic and financial indicators have little impact on the pricing of sovereign credit risk in all sample countries except Italy. But changes in the sovereign credit risk have significant impacts on domestic economic and financial indicators. Neglecting the financial contagion and feedback effects from sovereign credit risk to domestic economic and financial developments leads to spurious results regarding the determinants of sovereign CDS spreads.
Original languageEnglish
Pages (from-to)10-21
JournalJournal of Financial Stability
Volume22
DOIs
Publication statusPublished - Feb 2016

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Credit default swap (CDS) spreads
Euro area
Credit risk
Market uncertainty
Italy
Financial indicators
Factors
Pricing
Economic indicators
Economic development
Ireland
International financial markets
Spain
Contagion effect
Feedback effect
Jump risk
Contagion
European Monetary Union
Greece
Financial contagion

Keywords

  • regime switching
  • endogeneity
  • European debt crisis
  • sovereign credit default swap spread

Cite this

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title = "Regime-dependent determinants of Euro area sovereign CDS spreads",
abstract = "We study the determinants of sovereign CDS spreads of five Euro area countries (Greece, Ireland, Italy, Portugal, and Spain) after the collapse of Lehman Brothers. We find that global and/or European Monetary Union (EMU)-wide factors are the main drivers of changes in the sovereign CDS spreads in our sample. However, the impacts of those factors change with market uncertainty. There is a relatively tranquil regime where market uncertainty is low and a relatively turbulent regime where market uncertainty is high. The transition from the tranquil regime to the turbulent regime is driven by changes in the global jump risk, which suggests that contagion from the global financial market significantly affected the pricing of sovereign credit risk in our sample. Domestic economic and financial indicators have little impact on the pricing of sovereign credit risk in all sample countries except Italy. But changes in the sovereign credit risk have significant impacts on domestic economic and financial indicators. Neglecting the financial contagion and feedback effects from sovereign credit risk to domestic economic and financial developments leads to spurious results regarding the determinants of sovereign CDS spreads.",
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Regime-dependent determinants of Euro area sovereign CDS spreads. / Blommestein, H.J.; Eijffinger, Sylvester; Qian, Zongxin.

In: Journal of Financial Stability, Vol. 22, 02.2016, p. 10-21.

Research output: Contribution to journalArticleScientificpeer-review

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T1 - Regime-dependent determinants of Euro area sovereign CDS spreads

AU - Blommestein, H.J.

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AU - Qian, Zongxin

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N2 - We study the determinants of sovereign CDS spreads of five Euro area countries (Greece, Ireland, Italy, Portugal, and Spain) after the collapse of Lehman Brothers. We find that global and/or European Monetary Union (EMU)-wide factors are the main drivers of changes in the sovereign CDS spreads in our sample. However, the impacts of those factors change with market uncertainty. There is a relatively tranquil regime where market uncertainty is low and a relatively turbulent regime where market uncertainty is high. The transition from the tranquil regime to the turbulent regime is driven by changes in the global jump risk, which suggests that contagion from the global financial market significantly affected the pricing of sovereign credit risk in our sample. Domestic economic and financial indicators have little impact on the pricing of sovereign credit risk in all sample countries except Italy. But changes in the sovereign credit risk have significant impacts on domestic economic and financial indicators. Neglecting the financial contagion and feedback effects from sovereign credit risk to domestic economic and financial developments leads to spurious results regarding the determinants of sovereign CDS spreads.

AB - We study the determinants of sovereign CDS spreads of five Euro area countries (Greece, Ireland, Italy, Portugal, and Spain) after the collapse of Lehman Brothers. We find that global and/or European Monetary Union (EMU)-wide factors are the main drivers of changes in the sovereign CDS spreads in our sample. However, the impacts of those factors change with market uncertainty. There is a relatively tranquil regime where market uncertainty is low and a relatively turbulent regime where market uncertainty is high. The transition from the tranquil regime to the turbulent regime is driven by changes in the global jump risk, which suggests that contagion from the global financial market significantly affected the pricing of sovereign credit risk in our sample. Domestic economic and financial indicators have little impact on the pricing of sovereign credit risk in all sample countries except Italy. But changes in the sovereign credit risk have significant impacts on domestic economic and financial indicators. Neglecting the financial contagion and feedback effects from sovereign credit risk to domestic economic and financial developments leads to spurious results regarding the determinants of sovereign CDS spreads.

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KW - endogeneity

KW - European debt crisis

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