CDS Spreads in European Periphery: Some Technical Issues to Consider

March 1, 2012

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Format: Chicago

Manmohan Singh, and Mohsan Bilal. CDS Spreads in European Periphery: Some Technical Issues to Consider, (USA: International Monetary Fund, 2012) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper looks at some technical issues when using CDS data, and if these are incorporated, the analysis or regression results are likely to benefit. The paper endorses the use of stochastic recovery in CDS models when estimating probability of default (PD) and suggests that stochastic recovery may be a better harbinger of distress signals than fixed recovery. Similarly, PDs derived from CDS data are risk-neutral and may need to be adjusted when extrapolating to real world balance sheet and empirical data (e.g. estimating banks losses, etc). Another technical issue pertains to regressions trying to explain CDS spreads of sovereigns in peripheral Europe - the model specification should be cognizant of the under-collateralization aspects in the overall OTC derivatives market. One of the biggest drivers of CDS spreads in the region has been the CVA teams of the large banks that hedge their exposure stemming from derivative receivables due to non-posting of collateral by many sovereigns (and related entities).

Subject: Banking, Bonds, Collateral, Credit default swap, Derivative markets, Financial institutions, Financial markets, Money, Over-the-counter markets

Keywords: Bank, Bonds, CDS, CDS contract, CDS data, CDS recovery, CDS settlement, CDS signal, CDS spread, CDS spreads, Cheapest-to-deliver bonds, Collateral, Collateral use in OTC derivatives, Credit default swap, Derivative, Derivative markets, Europe, OTC derivative, Over-the-counter markets, Peripheral Europe, Price of risk, Probability of default, Stochastic recovery rate, WP

Publication Details

Pages:

18
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2012/077
Stock No:

WPIEA2012077
ISBN:

9781475502299
ISSN:

1018-5941

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