Government Intervention and the CDS Market: A Look at the Market’s Response to Policy Announcements During the 2007-2009 Financial Crisis

Abstract:     
This paper adds to the literature on the financial markets’ reaction to government interventions during the 2007-2009 financial crisis by analyzing the response of US firms’ credit default swap spreads to key government actions. We find that the government measures taken to stabilize both the financial sector and the overall economy were generally well-received by credit default swap (CDS) market participants, reducing perceived credit risk across a broad cross-section of firms. Financial firms responded most favorably to financial sector policies and interest rate cuts, with announcement date abnormal CDS spread changes of -5 and -2 percent, respectively. Non-financial firms responded most favorably to conventional fiscal and monetary policy tools with spread reductions of approximately one percent upon announcement of these measures.

Keywords: Government intervention, financial crisis, Credit default swaps, credit risk

Accepted Paper Series