Under-reaction in the Sovereign CDS Market

37 Pages Posted: 14 May 2019

See all articles by Yaqing Xiao

Yaqing Xiao

Rutgers University

Hongjun Yan

DePaul University

Jinfan Zhang

International Monetary Fund

Date Written: April 15, 2019

Abstract

The sovereign CDS market has been growing rapidly in recent years, with a gross notional amount of around 2 trillion dollars in 2015. We document a strong momentum effect in this market. Its unique feature is that this momentum strategy returns are positively skewed and higher during recessions. Hence, this effect cannot be attributed to momentum crash risk or exposure to business cycles. Our evidence is consistent with the interpretation that the effect is due to investors’ initial underreaction to sovereign credit information followed by corrections, especially during public 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

Xiao, Yaqing and Yan, Hongjun and Zhang, Jinfan, Under-reaction in the Sovereign CDS Market (April 15, 2019). Available at SSRN: https://ssrn.com/abstract=3372551 or http://dx.doi.org/10.2139/ssrn.3372551

Yaqing Xiao

Rutgers University ( email )

94 Rockafeller Road
New Brunswick, NJ 08901
United States

Hongjun Yan (Contact Author)

DePaul University ( email )

1 East Jackson Blvd.
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/view/hongjunyan

Jinfan Zhang

International Monetary Fund ( email )

700 19th St NW
Washington, DC 20431
United States

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