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Short-term determinants of the idiosyncratic sovereign risk premium: a regime-dependent analysis for European credit default swaps
journal contributionposted on 2016-03-23, 14:55 authored by Giovanni Calice, RongHui Miao, Filip Sterba, Borek Vasicek
This study investigates the dynamics of the sovereign CDS term premium, i.e. difference between 10Y and 5Y CDS spreads. It can be regarded a forward-looking measure of idiosyncratic sovereign default risk as perceived by financial markets. For some European countries this premium featured distinct nonstationary and heteroskedastic pattern during the last years. Using a Markov-switching unobserved component model, we decompose the daily CDS term premium of five European countries into two unobserved components of statistically different nature and link them in a vector autoregression to various daily observed financial market variables. We find that such decomposition is vital for understanding the short-term dynamics of this premium. The strongest impacts can be attributed to CDS market liquidity, local stock returns, and overall risk aversion. By contrast, the impact of shocks from the sovereign bond market is rather muted. Therefore, the CDS market microstructure effect and investor sentiment play the main roles in sovereign risk evaluation in real time. Moreover, we also find that the CDS term premium response to shocks is regime-dependent and can be ten times stronger during periods of high volatility.
- Business and Economics
Published inJournal of Empirical Finance
Pages174 - 189 (16)
CitationCALICE, G. ... et al., 2015. Short-term determinants of the idiosyncratic sovereign risk premium: a regime-dependent analysis for European credit default swaps. Journal of Empirical Finance, 33, pp.174-189.
- AM (Accepted Manuscript)
Publisher statementThis work is made available according to the conditions of the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International (CC BY-NC-ND 4.0) licence. Full details of this licence are available at: https://creativecommons.org/licenses/by-nc-nd/4.0/
NotesThis paper was accepted for publication in the journal Journal of Empirical Finance and the definitive published version is available at http://dx.doi.org/10.1016/j.jempfin.2015.03.018