Credit default swaps and the market for sovereign debt |
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Institution: | 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 |
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Abstract: | In this paper, we analyze the determinants and effects of credit default swap (CDS) trading initiation in the sovereign bond market. CDS trading initiation is associated with a 30–150 basis point reduction in sovereign bond yields, with greater yield reductions accruing to higher default risk economies. For countries with high default risk, rated B or lower by Standard and Poor’s, CDS initiation is also associated with significant price efficiency benefits in the underlying market. CDS trading initiation is more likely following increases in local equity index volatility, index spreads for regional and global CDS markets, or depreciation of the local currency relative to the US dollar, and decreases in a country’s ability to service foreign debt. Our results are robust to selection bias controls based on these factors. |
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Keywords: | Credit default swaps Sovereign bonds Borrowing costs Price efficiency Credit risk |
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