Liquidity Spillovers in Sovereign Bond and CDS Markets: An Analysis of The Eurozone Sovereign Debt Crisis

48 Pages Posted: 29 Jul 2011 Last revised: 9 Oct 2017

See all articles by Giovanni Calice

Giovanni Calice

Loughborough University

Jing Chen

Cardiff University - School of Mathematics

Julian M. Williams

Durham Business School

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2011

Abstract

At the end of 2009, countries in the Eurozone began to experience a sudden divergence of bond yields as the perceived prospect of sovereign default risk increased. This paper examines the potential spillovers between the liquidity of the sovereign credit default swap (CDS) market and the liquidity of the sovereign bond market for a group of Eurozone countries. Empirically, we consider the differential spread on various Eurozone members sovereign bonds over the equivalent German benchmark. Using a unique dataset, constructed from the tick by tick transaction history from the 5-10 year maturity of the sovereign bond and CDS markets, we find that for countries such as Portugal, Spain and Ireland, the CDS market reveals a growing influence on bond yields post 2009. We provide substantial evidence that Greek sovereign CDS spreads and debt spreads do not exhibit the same time varying correlative patterns. Furthermore, we suggest that CDS spreads and bond credit spreads for Greek debt have correctly priced the default risk and that the trend patterns observed have not been substantially affected by changes in the liquidity profiles of either market. On a general note, we show that the bond yield liquidity spreads have increased substantially over the 2007-2010 period whilst CDS liquidity spreads have fallen dramatically. For some countries, such as Portugal, liquidity risk plays an important role in the sovereign bond market.

Keywords: credit derivatives, liquidity, sovereign bonds, credit spreads

JEL Classification: G11, G12, G14

Suggested Citation

Calice, Giovanni and Chen, Jing and Williams, Julian M., Liquidity Spillovers in Sovereign Bond and CDS Markets: An Analysis of The Eurozone Sovereign Debt Crisis (January 1, 2011). Paolo Baffi Centre Research Paper No. 2011-105, Available at SSRN: https://ssrn.com/abstract=1898596 or http://dx.doi.org/10.2139/ssrn.1898596

Giovanni Calice (Contact Author)

Loughborough University ( email )

Ashby Road
Loughborough, LE11 3TU
Great Britain

Jing Chen

Cardiff University - School of Mathematics ( email )

Senghennydd Road
Cardiff, CF24 4AG
United Kingdom

Julian M. Williams

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

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