Nonlinearities in Sovereign Risk Pricing: The Role of CDS Index Contracts
Nonlinearities in Sovereign Risk Pricing: The Role of CDS Index Contracts
Is the pricing of sovereign risk linear during bearish episodes? Or can initial shocks on economic fundamentals be exacerbated by endogenous factors that create nonlinearities? We test for nonlinearities in the sovereign bond market of European peripheral countries during the debt crisis and explain them. Our estimates based on a panel smooth threshold regression model during January 2006 to September 2012 show four main findings: 1) Peripheral sovereign spreads are subject to significant nonlinear dynamics. 2) The deterioration of mark et conditions for financial names changes the way investors price risk of the sovereigns. 3) The spreads of European peripheral countries have been priced above their historical values, given fundamentals, because of amplification effects. 4) Two CDS indices on financial names unambiguously stand out as leading drivers of these amplification effects.
Panel Smooth Threshold Regression Models, 330, Panel Smooth Threshold, CDS indices, E.E4.E44 - Financial Markets and the Macroeconomy, CDS indices; European sovereign crisis; Panel Smooth Threshold Regression Models, 339, JEL: H - Public Economics/H.H6 - National Budget, Macroéconomie, F34, G12, and Debt/H.H6.H63 - Debt • Debt Management • Sovereign Debt, [SHS.ECO] Humanities and Social Sciences/Economics and Finance, Deficit, JEL: E - Macroeconomics and Monetary Economics/E.E4 - Money and Interest Rates/E.E4.E44 - Financial Markets and the Macroeconomy, JEL: C - Mathematical and Quantitative Methods/C.C2 - Single Equation Models • Single Variables/C.C2.C23 - Panel Data Models • Spatio-temporal Models, European sovereign crisis; Panel Smooth Threshold Regression Models; CDS indices;, European sovereign crisis, [SHS.ECO]Humanities and Social Sciences/Economics and Finance, C.C2.C23 - Panel Data Models • Spatio-temporal Models, Regression Models, JEL: F - International Economics/F.F3 - International Finance/F.F3.F34 - International Lending and Debt Problems, F.F3.F34 - International Lending and Debt Problems, E44, H63, G.G1.G12 - Asset Pricing • Trading Volume • Bond Interest Rates, H.H6.H63 - Debt • Debt Management • Sovereign Debt, JEL: G - Financial Economics/G.G1 - General Financial Markets/G.G1.G12 - Asset Pricing • Trading Volume • Bond Interest Rates, C23, jel: jel:C23, jel: jel:E44, jel: jel:H63, jel: jel:G12, jel: jel:F34
Panel Smooth Threshold Regression Models, 330, Panel Smooth Threshold, CDS indices, E.E4.E44 - Financial Markets and the Macroeconomy, CDS indices; European sovereign crisis; Panel Smooth Threshold Regression Models, 339, JEL: H - Public Economics/H.H6 - National Budget, Macroéconomie, F34, G12, and Debt/H.H6.H63 - Debt • Debt Management • Sovereign Debt, [SHS.ECO] Humanities and Social Sciences/Economics and Finance, Deficit, JEL: E - Macroeconomics and Monetary Economics/E.E4 - Money and Interest Rates/E.E4.E44 - Financial Markets and the Macroeconomy, JEL: C - Mathematical and Quantitative Methods/C.C2 - Single Equation Models • Single Variables/C.C2.C23 - Panel Data Models • Spatio-temporal Models, European sovereign crisis; Panel Smooth Threshold Regression Models; CDS indices;, European sovereign crisis, [SHS.ECO]Humanities and Social Sciences/Economics and Finance, C.C2.C23 - Panel Data Models • Spatio-temporal Models, Regression Models, JEL: F - International Economics/F.F3 - International Finance/F.F3.F34 - International Lending and Debt Problems, F.F3.F34 - International Lending and Debt Problems, E44, H63, G.G1.G12 - Asset Pricing • Trading Volume • Bond Interest Rates, H.H6.H63 - Debt • Debt Management • Sovereign Debt, JEL: G - Financial Economics/G.G1 - General Financial Markets/G.G1.G12 - Asset Pricing • Trading Volume • Bond Interest Rates, C23, jel: jel:C23, jel: jel:E44, jel: jel:H63, jel: jel:G12, jel: jel:F34
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