How Sovereign is Sovereign Credit Risk? Global Prices, Local Quantities

Abstract

Sovereign default insurance price fluctuations are dominated by common risks. In contrast, fluctuations in their quantities are primarily explained by country-specific factors. Using net positions in sovereign default insurance contracts for 60 countries between 2008 and 2015, we show that a country's debt and size explain 75% of cross-country differences in net insured interest. We develop an economic framework showing that high commonality in prices and low commonality in quantities can arise jointly only if insurance demand and supply shift in opposite directions in response to global shocks. We identify hedge funds as primary net suppliers of sovereign default protection.

Keywords: credit default swaps, credit risk, debt, demand and supply, OTC

JEL Classification: C3, E44, F34, G12, G15, H63