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The Link between Eurozone Sovereign Debt and CDS Prices

Authors :
Dominic O'Kane

Affiliated Professor of Finance, EDHEC Business School

This study performs a theoretical and empirical analysis of the relationship between the price of Eurozone sovereign-linked credit default swaps (CDS) and the same sovereign bond markets during the Eurozone debt crisis of 2009-2011.

EDHEC Working Paper

EDHEC Working Paper

We first present a simple model which establishes the no-arbitrage relationship between CDS and bond yield spreads. We then test this relationship empirically and explain why the market may deviate from it. Reasons include the different currencies of denomination of market-standard CDS and their reference obligations. We also examine whether CDS spread cause changes in bond spreads, and vice-versa, in a Granger sense.
We find evidence for a Granger causal relationship with a one day lag from CDS to bonds for Greece and Spain, the reverse relationship for France and Italy and a feedback relationship for Ireland and Portugal.
Type :
Working Paper
Dates :
Created on January 13, 2012
Further information :
For more information, please contact EDHEC Research and Development Department [ research@drd.edhec.edu ]

Finance


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