Market Perception of Sovereign Credit Risk in the Euro Area During the Financial Crisis
46 Pages Posted: 19 Aug 2015
Date Written: September 10, 2014
We study market perception of sovereign credit risk in the Euro area during the financial crisis. In our analysis we use a parsimonious CDS pricing model to estimate market implied measures of the probability of default (PD) and of the loss given default (LGD). We find that separate identification of PD and LGD appears empirically tractable for a numer of Euro area countries. In our empirical results the estimated market implied LGDs stay comfortably below 40% in most of the samples. We also find that macroeconomic and institutional developments were only weakly correlated with the market perception of sovereign credit risk, whereas financial contagion appears to have exerted a non-negligible effect.
Keywords: sovereign credit risk, CDS spreads, euro area, probability of default
JEL Classification: C11, C32, G01, G12, G15
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