Non-Default Component of Sovereign Emerging Market Yield Spreads and Its Determinants: Evidence from Credit Default Swap Market

Posted: 21 May 2019

Date Written: January 1, 2009

Abstract

In this paper, I show that a sizable component of emerging market sovereign yield spreads is due to factors other than default risk such as liquidity. I estimate the non-default component of the yield spreads as the basis between the actual credit default swap (CDS) premium and the hypothetical CDS premium implied by emerging market bond yields. On average, the basis is large and positive for speculative grade bonds and slightly negative for investment grade bonds. This large positive basis for speculative grade bonds support the existence of speculation in the CDS market when the underlying's credit quality is bad. I study the effects of bond liquidity, liquidity in the CDS market, equity market performance and macroeconomic variables on the non-default component of the emerging market yield spreads. I show that bond liquidity has a significant and positive effect on the CDS-bond basis of investment grade bonds. The results suggest that the liquid bonds of investment grade bonds are more expensive relative to the prices implied their CDS premiums. However, the results are somewhat mixed and even contrary for the speculative grade bond sample.

Keywords: Credit Default Swaps, Emerging Market Yield Spreads, Credit Risk, Basis, Non-default Component, Liquidity

JEL Classification: G10, G12, G15

Suggested Citation

Kucuk, Ugur Namik, Non-Default Component of Sovereign Emerging Market Yield Spreads and Its Determinants: Evidence from Credit Default Swap Market (January 1, 2009). Journal of Fixed Income, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1395966

Ugur Namik Kucuk (Contact Author)

University of Rome Tor Vergata ( email )

Via di Tor Vergata
Rome, Lazio 00133
Italy

HOME PAGE: http://www.economia.uniroma2.it/phd/money-finance/default.asp?a=284&oc=664&d=905

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