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Liquidity spillovers in sovereign bond and CDS markets: An analysis of the Eurozone sovereign debt crisis

Giovanni Calice, Maggie Chen, Julian Williams

Journal of Economic Behavior & Organization, Volume: 85, Pages: 122 - 143

Swansea University Author: Maggie Chen

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DOI (Published version): 10.1016/j.jebo.2011.10.013

Abstract

At the end of 2009, countries in the Eurozone (euro area) began to experience a sudden divergence of bond yields as the market perception of sovereign default risk increased. The theory of complete markets suggests that sovereign debt and credit default swap (CDS) credit spreads should track each ot...

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Published in: Journal of Economic Behavior & Organization
ISSN: 0167-2681
Published: 2013
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URI: https://cronfa.swan.ac.uk/Record/cronfa6969
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Abstract: At the end of 2009, countries in the Eurozone (euro area) began to experience a sudden divergence of bond yields as the market perception of sovereign default risk increased. The theory of complete markets suggests that sovereign debt and credit default swap (CDS) credit spreads should track each other closely. In addition, liquidity risk should be priced into both instruments in such a way that buying exposure to the same default risk is identically priced. We use a time-varying vector autoregression framework to establish the credit and liquidity spreads interactions over the 2009-2010 crisis period. We nd substantial variation in the patterns of the transmission effect between maturities and across countries. Our major result is that for several countries, including Greece, Ireland and Portugal the liquidity of the sovereign CDS market has a substantial time varying inuence on sovereign bond credit spreads. This evidence is of particular importance in the current policy context.
College: Faculty of Humanities and Social Sciences
Start Page: 122
End Page: 143

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