Under-reaction in the Sovereign CDS Market

43 Pages Posted: 14 May 2019 Last revised: 24 May 2021

See all articles by Xinjie Wang

Xinjie Wang

Southern University of Science and Technology

Yaqing Xiao

Capital University of Economics and Business

Hongjun Yan

DePaul University

Jinfan Zhang

Chinese University of Hong Kong (Shenzhen)

Date Written: May 23, 2021

Abstract

The sovereign CDS market has developed rapidly for two decades and currently has a gross
notional amount of more than a trillion dollars. We document a strong momentum effect in this
market, which cannot be explained by a large set of risk factors. These momentum returns are
positively skewed and higher during recessions. Consistent with the interpretation that this
momentum effect is due to investors’ initial underreaction to sovereign credit information followed
by corrections, our evidence shows that the momentum returns tend to be higher during the months
surrounding announcements of credit rating or outlook changes of the underlying countries.

Keywords: Underreaction, Macro information, Sovereign CDS, Predictability, Limits to arbitrage

JEL Classification: G12

Suggested Citation

Wang, Xinjie and Xiao, Yaqing and Yan, Hongjun and Zhang, Jinfan, Under-reaction in the Sovereign CDS Market (May 23, 2021). Journal of Banking and Finance, Accepted, Available at SSRN: https://ssrn.com/abstract=3372551 or http://dx.doi.org/10.2139/ssrn.3372551

Xinjie Wang

Southern University of Science and Technology ( email )

1088 Xueyuan Blvd
Xili, Nanshan District
Shenzhen, Guangdong 518055
China

Yaqing Xiao

Capital University of Economics and Business ( email )

Beijing
China

Hongjun Yan (Contact Author)

DePaul University ( email )

1 East Jackson Blvd.
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/hongjunyanhomepage/

Jinfan Zhang

Chinese University of Hong Kong (Shenzhen) ( email )

Shenzhen
China

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