Credit Default Swaps and Sovereign Debt Markets

Networks Financial Institute Working Paper 2011-WP-03

39 Pages Posted: 8 Mar 2011

See all articles by M. Kabir Hassan

M. Kabir Hassan

University of New Orleans - College of Business Administration - Department of Economics and Finance

Geoffrey M. Ngene

University of New Orleans - College of Business Administration - Department of Economics and Finance

Jung-Suk Yu

School of Urban Planning & Real Estate Studies, Dankook University

Date Written: March 1, 2011

Abstract

This study investigates the link between price discovery dynamics in sovereign credit default swaps (CDS) and bond markets and degree of financial integration of emerging markets. Using CDS and sovereign bond spreads, the price discovery mechanism was tested using a vector error correction model. Financial integration is measured using news-based methods. We find that sovereign CDS and bond markets are co-integrated. In 57 percent of times, the CDS market leads in price discovery by adjusting before bonds to new information regarding credit risk. In 29 percent of times, bond markets are sources of price discovery. We also find a strong positive correlation of 0.84 between degree of financial integration and bond market information share. The evidence suggests that changes in sovereign credit risk and bond yields are significantly influenced by common external (global) factors while country specific factors play an insignificant role.

Keywords: Price discovery, financial integration, CDS, sovereign bonds, credit risk

JEL Classification: C13, E43, G15

Suggested Citation

Hassan, M. Kabir and Ngene, Geoffrey M. and Yu, Jung-Suk, Credit Default Swaps and Sovereign Debt Markets (March 1, 2011). Networks Financial Institute Working Paper 2011-WP-03, Available at SSRN: https://ssrn.com/abstract=1777423 or http://dx.doi.org/10.2139/ssrn.1777423

M. Kabir Hassan (Contact Author)

University of New Orleans - College of Business Administration - Department of Economics and Finance ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States

Geoffrey M. Ngene

University of New Orleans - College of Business Administration - Department of Economics and Finance ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States

Jung-Suk Yu

School of Urban Planning & Real Estate Studies, Dankook University ( email )

152, Jukjeon-ro, Suji-gu, Yongin-si
Gyeonggi-do, 16890
Korea, Republic of (South Korea)

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