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Do Major Financial Crises Provide Information on Sovereign Risk to the Rest of the World? A Look at Credit Default Swap Markets

Author

Listed:
  • Didier Cossin

    (IMD International and FAME)

  • Gero Jung

    (Graduate Institute of International Studies)

Abstract

The financial innovations of the late 1990s have led to the emergence of a significant number of new instruments, in particular in the market for hedging credit risk. This paper, based on an original dataset of transactions and quotes, looks at credit default swaps drawn on sovereign countries. The study of the credit default swap market around major financial crises leads to several results: Markets' consideration of ratings around the world changes dramatically after major financial crises, even for those countries that are not in crisis. While ratings seem suddenly to matter more, pricing uncertainty increases as well. Thus large financial crises appear to create strong information uncertainty, rather than resolve previous uncertainty. After a major crisis event, there is significant ‘flight-to-quality’ that is accompanied by a strong relative rise of demand for sovereign credit protection. We also document the extra-significance of transaction data compared to quote data in an OTC market. Overall, sovereign ratings appear to be the pricing tool of last resort when crises disturb markets.

Suggested Citation

  • Didier Cossin & Gero Jung, 2005. "Do Major Financial Crises Provide Information on Sovereign Risk to the Rest of the World? A Look at Credit Default Swap Markets," FAME Research Paper Series rp134, International Center for Financial Asset Management and Engineering.
    • Handle: RePEc:fam:rpseri:rp134
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    Citations

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    Cited by:

    1. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.
    2. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    3. Goderis, Benedikt & Wagner, Wolf, 2009. "Credit Derivatives and Sovereign Debt Crises," MPRA Paper 17314, University Library of Munich, Germany.

    More about this item

    Keywords

    Credit Default Swaps; Sovereign Risk; Financial Crises; Event Study;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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