Under-reaction in the Sovereign CDS Market
37 Pages Posted: 14 May 2019
Date Written: April 15, 2019
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: Suggested Citation