Sovereign and Bank CDS Spreads: Two Sides of the Same Coin?

24 Pages Posted: 22 Jun 2013 Last revised: 4 Apr 2014

See all articles by Davide E. Avino

Davide E. Avino

University of Liverpool; Financial Mathematics and Computation Cluster

John Cotter

University College Dublin; UCLA Anderson School of Management

Date Written: April 04, 2014

Abstract

This paper investigates the relationship between sovereign and bank CDS spreads with reference to their ability to convey timely signals on the default risk of European sovereign countries and their banking systems. By using a sample of six major European economies, we find that sovereign and bank CDS spreads are cointegrated variables at the country level. We then perform a more in-depth investigation of the underlying price discovery mechanisms. By decomposing the noise and speed of adjustment components of the price discovery, we find that both variables have an important price discovery role in the period 2004-2013. Most developed countries (Germany, Sweden) show a clear leading role for bank CDS spreads throughout the sample period, whereas most distressed European economies (Portugal and Spain) are governed by a leading role for their sovereign CDS spreads during both the sub-prime crisis and the subsequent European sovereign debt crisis.

Keywords: Credit default swap spreads, price discovery, information flow, financial crisis, banks, sovereign risk, bank capital, contingent capital

JEL Classification: G01, G12, G14, G20, D8

Suggested Citation

Avino, Davide E. and Cotter, John, Sovereign and Bank CDS Spreads: Two Sides of the Same Coin? (April 04, 2014). Available at SSRN: https://ssrn.com/abstract=2282587 or http://dx.doi.org/10.2139/ssrn.2282587

Davide E. Avino (Contact Author)

University of Liverpool ( email )

Chatham Street
Liverpool, L69 7ZA
United Kingdom

Financial Mathematics and Computation Cluster

Dublin
Ireland

John Cotter

University College Dublin ( email )

School of Business, Carysfort Avenue
Blackrock, Co. Dublin
Ireland
353 1 716 8900 (Phone)
353 1 283 5482 (Fax)

HOME PAGE: http://www.ucd.ie/bankingfinance/staff/professorjohncotter/

UCLA Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

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