When is There a Strong Transfer Risk from the Sovereigns to the Corporates? -- Property Rights Gaps and CDS Spreads

Abstract

When a sovereign faces the risk of debt default, it attempts to expropriate the private sector. But the likelihood of a transfer from the sovereign risk to corporate default risk can be mitigated by legal institutions that provide strong property rights protection. Using a novel credit default swaps (CDS) dataset covering both government and corporate entities across 30 countries, this paper studies the strength of the transfer risk and the role of institutions in mitigating such risk. We find that sovereign risk on average has a statistically and economically significant influence on corporate credit risk. All else equal, a 100 basis points increase in the sovereign CDS spread leads to an increase in corporate CDS spreads by 74 basis points. The sovereign–corporate relation varies across corporations, with state-owned companies exhibiting a stronger relation. However, strong property rights institutions tend to weaken the connection. In contrast, contracting institutions (protection of creditor rights or minority shareholder rights) do not appear to matter in this context.

Keywords: sovereign risk; CDS; property rights institutions; contracting institutions; transfer risk

JEL Classification: G15, G38