Does Monetary Policy Impact Sovereign Credit Risk Comovement?

Abstract

This paper shows that FED policy announcements are accompanied with a significant increase in international co-movement in the sovereign CDS market. The effect is strongest for emerging markets, when the FED relaxes unconventional monetary policies, and for countries that are open to the trading of goods and flows, even with floating exchange rates. The announcements also affect closed economies whose currencies are pegged to the dollar. The evidence is consistent with recent theories of a global financial cycle and the pricing of a FED put. In contrast, ECB announcements hardly affect co-movement, even in the Eurozone.

Keywords: Sovereign credit risk, Monetary Policy, Quantitative easing, Mundellian trilemma, Comovement