Market frictions and the pricing of sovereign credit default swaps |
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| Affiliation: | 1. Department of Financial Economics, University of Alicante, 03690 San Vicente del Raspeig, Alicante, Spain;2. Department of Economic Analysis and Finance, University of Castilla la Mancha, 45071 Toledo, Spain;3. Department of Business Administration, University Carlos III, c/Madrid, 126, 28903 Getafe, Madrid, Spain;1. LEO-Laboratoire d''Economie d''Orléans, University of Orléans, France;2. Lebow College of Business, Drexel University, Philadelphia, PA, USA;3. IPAG Business School, Paris, France;4. Department of Economics, University of Pretoria, Pretoria 0002, South Africa;1. Strome College of Business, Old Dominion University, Constant Hall, Suite 2080, Norfolk, VA 23529-0222, USA;2. Judge Business School, Cambridge University, United Kingdom;3. University of York, Freeboys Lane, YO10 5GD, United Kingdom |
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| Abstract: | This paper contributes to the general understanding of how sovereign CDS prices are formed by studying the information content of pricing errors generated by a non-arbitrage model. We implement a price-discrepancy measure in the spirit of the noise measure introduced by Hu et al. (2013) in the Treasury Bond market, and analyze its main determinants in panel data analysis. The main results show that sovereign CDS pricing errors are systematically related to higher bid-ask spreads. The evidence in this paper also suggests that exits of capital arbitrage during distressed periods, as measured by changes in net offsetting, can be associated to larger pricing errors in sovereign CDS from advanced economies, thereby supporting the main claims of the limit-to-arbitrage theories. These findings are robust for the most common CDS pricing models employed in the industry and different estimation techniques. |
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