Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market |
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| Institution: | 1. University of Technology Sydney, UTS Business School, City Campus, PO Box 123 Broadway, NSW 2007, Australia;2. Norges Bank, Bankplassen 2, P.O. Box 1179 Sentrum, 0107 Oslo, Norway;1. Department of Economics, Michigan State University, East Lansing, MI 48824-1024, USA;2. Department of Finance, Michigan State University, East Lansing, MI 48824-1024, USA;3. School of Economics and Finance, Queen Mary University of London, UK;4. Rimini Center for Economic Analysis, Italy;5. Department of Economics, Kookmin University, Seoul, Republic of Korea;1. Faculty of Business and Economics, Extranef 232, Department of Finance, University of Lausanne, CH 1015 Lausanne, Switzerland;2. Swiss Finance Institute, Switzerland;1. Department of Economics, Erasmus University Rotterdam, P.O. Box 1738, 3000DR, The Netherlands;2. Economics and Research Division, De Nederlandsche Bank, P.O. Box 98, 1000AB, The Netherlands |
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| Abstract: | This paper proposes a model for credit default swap (CDS) spreads under heterogeneous expectations to explain the escalation in sovereign European CDS spreads and the widening variations across European sovereigns following the Global Financial Crisis (GFC). In our model, investors believe that sovereign CDS spreads are determined by country-specific fundamentals and momentum. By estimating the model we find evidence that, while some of the recent movements in sovereign CDS spreads can be explained by deteriorating fundamentals for core European Union (EU) countries, momentum has also played a destabilizing role since the GFC in all sovereign credit markets studied. |
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