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Sovereign debt and credit default swaps

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Listed:
  • Chaumont, Gaston
  • Gordon, Grey
  • Sultanum, Bruno
  • Tobin, Elliot

Abstract

How do credit default swaps (CDS) affect sovereign debt markets? We analyze how liquidity, exposure to default risk, and regulation affect the answer to this question using a sovereign debt model where investors trade bonds and CDS over the counter via directed search. Restricting portfolios can improve bond prices and bond-market activity, but the net effect depends on relative frictions in bond and CDS markets, the exposure of investors, and how the sovereign responds to the policy. Our novel identification strategy exploits confidential microdata to quantify trading frictions and the exposure distribution. The calibrated model generates realistic CDS-bond basis deviations, bid–ask spreads, and CDS volumes and positions. Our baseline specification predicts trading frictions and an inability to short sell bonds significantly improves sovereign debt prices, but policies that restrict CDS trading have small effects.

Suggested Citation

  • Chaumont, Gaston & Gordon, Grey & Sultanum, Bruno & Tobin, Elliot, 2024. "Sovereign debt and credit default swaps," Journal of International Economics, Elsevier, vol. 150(C).
    • Handle: RePEc:eee:inecon:v:150:y:2024:i:c:s002219962400045x
    DOI: 10.1016/j.jinteco.2024.103921
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    1. Salomao, Juliana, 2017. "Sovereign debt renegotiation and credit default swaps," Journal of Monetary Economics, Elsevier, vol. 90(C), pages 50-63.
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    More about this item

    Keywords

    Sovereign debt; CDS; Directed search; Over-the-counter;
    All these keywords.

    JEL classification:

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

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