Sovereign CDS Spreads in Europe: The Role of Global Risk Aversion, Economic Fundamentals, Liquidity, and Spillovers

January 28, 2014

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Frigyes F Heinz, and Yan M Sun. Sovereign CDS Spreads in Europe: The Role of Global Risk Aversion, Economic Fundamentals, Liquidity, and Spillovers, (USA: International Monetary Fund, 2014) 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

By analysing data from January 2007 to December 2012 in a panel GLS error correction framework we find that European countries’ sovereign CDS spreads are largely driven by global investor sentiment, macroeconomic fundamentals and liquidity conditions in the CDS market. But the relative importance of these factors changes over time. While during the 2008/09 crisis weak economic fundamentals (such as high current account decifit, worsening underlying fiscal balances, credit boom), a drop in liquidity and a spike in risk aversion contributed to high spreads in Central and Eastern and South-Eastern European (CESEE) countries, a marked improvement in fundamentals (e.g. reduction in fiscal deficit, narrowing of current balances, gradual economic recovery) explains the region’s resilience to financial market spillovers during the euro area crisis. Our generalised variance decomposition analyisis does not suggest strong direct spillovers from the euro area periphery. The significant drop in the CDS spreads between July 2012 and December 2012 was mainly driven by a decline in risk aversion as suggested by the model’s out of sample forecasts.

Subject: Asset and liability management, Balance of payments, Credit default swap, Current account balance, Financial sector policy and analysis, Government debt management, Liquidity, Money, Public financial management (PFM), Spillovers

Keywords: Area CDS, Area crisis, Baltics, CDS bid, CDS market liquidity condition, CDS spread, CDS spreads, CESEE countries, CESEE country, Credit default swap, Current account balance, Financial market, Financial spillovers, Global, Government debt management, Liquidity, Norm decomposition, Periphery country, Real GDP, Sovereign CDS, Spillovers, WP

Publication Details

Pages:

77
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2014/017
Stock No:

WPIEA2014017
ISBN:

9781484393017
ISSN:

1018-5941

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