An Analysis of Euro Area Sovereign CDS and Their Relation with Government Bonds

49 Pages Posted: 4 Dec 2010

See all articles by Alessandro Fontana

Alessandro Fontana

European Insurance and Occupational Pensions Authority

Martin Scheicher

European Central Bank (ECB)

Date Written: November 4, 2010

Abstract

This paper studies the relative pricing of euro area sovereign CDS and the underlying government bonds. Our sample comprises weekly CDS and bond spreads of ten euro area countries for the period from January 2006 to June 2010. We first compare the determinants of CDS spreads and bond spreads and test how the crisis has affected market pricing. Then we analyse the ‘basis’ between CDS spreads and bond spreads and which factors drive pricing differences between the two markets. Our first main finding is that the recent repricing of sovereign credit risk in the CDS market seems mostly due to common factors. Second, since September 2008, CDS spreads have on average exceeded bond spreads, which may have been due to ‘flight to liquidity’ effects and limits to arbitrage. Third, since September 2008, market integration for bonds and CDS varies across countries: In half of the sample countries, price discovery takes place in the CDS market and in the other half, price discovery is observed in the bond market.

Keywords: Credit Spread, CDS, government bond, financial crisis, limits to arbitrage

JEL Classification: G00, G01

Suggested Citation

Fontana, Alessandro and Scheicher, Martin, An Analysis of Euro Area Sovereign CDS and Their Relation with Government Bonds (November 4, 2010). ECB Working Paper No. 1271, Available at SSRN: https://ssrn.com/abstract=1715483 or http://dx.doi.org/10.2139/ssrn.1715483

Alessandro Fontana (Contact Author)

European Insurance and Occupational Pensions Authority ( email )

Frankfurt
Germany

HOME PAGE: http://https://sites.google.com/site/alessandrofontanagfri/home

Martin Scheicher

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 (Phone)
+49 69 1344 7949 (Fax)

HOME PAGE: http://www.ecb.europa.eu

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