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Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market

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  • Chiarella, Carl
  • ter Ellen, Saskia
  • He, Xue-Zhong
  • Wu, Eliza

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.

Suggested Citation

  • Chiarella, Carl & ter Ellen, Saskia & He, Xue-Zhong & Wu, Eliza, 2015. "Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market," Journal of Empirical Finance, Elsevier, vol. 32(C), pages 19-34.
    • Handle: RePEc:eee:empfin:v:32:y:2015:i:c:p:19-34
    DOI: 10.1016/j.jempfin.2014.11.003
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    More about this item

    Keywords

    Sovereign credit risk; European debt crisis; Heterogeneous beliefs; Momentum; CDS pricing;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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