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Measuring Sovereign Risk: Are CDS Spreads Better than Sovereign Credit Ratings?

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  • Iván M. Rodríguez
  • Krishnan Dandapani
  • Edward R. Lawrence

Abstract

Using data for 54 countries over a 12‐year period, we find that the variation in average sovereign ratings in a given year can be explained by average credit default swap (CDS) spreads over the previous three years. In a horse race between CDS spreads and sovereign ratings, we find that CDS spread changes can predict sovereign events, while rating changes cannot. The predictability of CDS spreads is greater when there is disagreement between Moody's and the S&P for a country's rating.

Suggested Citation

  • Iván M. Rodríguez & Krishnan Dandapani & Edward R. Lawrence, 2019. "Measuring Sovereign Risk: Are CDS Spreads Better than Sovereign Credit Ratings?," Financial Management, Financial Management Association International, vol. 48(1), pages 229-256, March.
    • Handle: RePEc:bla:finmgt:v:48:y:2019:i:1:p:229-256
    DOI: 10.1111/fima.12223
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    2. Mustafa Akay & Berat Bayram & Abdullah Kazdal & Muhammed Hasan Yilmaz, 2020. "Investigating Regime-Dependent Dynamics in Country Risk Premium: Evidence from Turkey and Emerging Markets," CBT Research Notes in Economics 2008, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    3. Anand, Arsh & Vanpée, Rosanne & Lončarski, Igor, 2023. "Sustainability and sovereign credit risk," International Review of Financial Analysis, Elsevier, vol. 86(C).
    4. Rodríguez-Caballero, Carlos Vladimir & Caporin, Massimiliano, 2019. "A multilevel factor approach for the analysis of CDS commonality and risk contribution," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 63(C).
    5. Yuting Gong & Zhongzhi He & Wenjun Xue, 2023. "EPU spillovers and sovereign CDS spreads: A cross‐country study," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(12), pages 1770-1806, December.
    6. Nader Naifar, 2020. "What Explains the Sovereign Credit Default Swap Spreads Changes in the GCC Region?," JRFM, MDPI, vol. 13(10), pages 1-22, October.
    7. Taurai Muvunza & Yong Jiang, 2023. "Determinants and hedging effectiveness of China's sovereign credit default swaps," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(2), pages 2074-2087, April.
    8. Chang, Jeffery (Jinfan) & Du, Huancheng & Lou, Dong & Polk, Christopher, 2022. "Ripples into waves: Trade networks, economic activity, and asset prices," Journal of Financial Economics, Elsevier, vol. 145(1), pages 217-238.
    9. Singhal, Himanshu & Verma, Arushi & Chakraborty, Madhumita, 2024. "The quality of credit ratings amid geopolitical risk," Economics Letters, Elsevier, vol. 234(C).
    10. Rathi, Sawan & Mohapatra, Sanket & Sahay, Arvind, 2022. "Central bank gold reserves and sovereign credit risk," Finance Research Letters, Elsevier, vol. 45(C).
    11. Tamás Kristóf, 2021. "Sovereign Default Forecasting in the Era of the COVID-19 Crisis," JRFM, MDPI, vol. 14(10), pages 1-24, October.
    12. Rathi, Sawan & Mohapatra, Sanket & Sahay, Arvind, 2021. "Central bank gold reserves and sovereign credit risk," IIMA Working Papers WP 2021-03-02, Indian Institute of Management Ahmedabad, Research and Publication Department.

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