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Are Credit Default Swaps Spreads High in Emerging Markets: An Alternative Methodology for Proxying Recovery Value

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  • Mr. Manmohan Singh

Abstract

In times of distress when a country loses access to markets, there is evidence that credit default swap (CDS) spreads are a leading indicator for sovereign risk than the EMBI+ sub-index for the country. However, it is not easy to discern the variables that determine the level of CDS spreads in Emerging Markets (EM); traders only quote the CDS spreads and not the inputs that are required to calculate such spreads. This note provides some evidence from Argentina and Brazil that reveals inconsistency between theory and practice in pricing CDS spreads in EM. This note suggests an alternate methodology that links CTD (cheapest-to-deliver) bonds to recovery values assumed in CDS contracts. Furthermore, special features that pertain to CDS contracts (repo specialness, short squeezes by central banks) may also magnify the financial distress of a sovereign.

Suggested Citation

  • Mr. Manmohan Singh, 2003. "Are Credit Default Swaps Spreads High in Emerging Markets: An Alternative Methodology for Proxying Recovery Value," IMF Working Papers 2003/242, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2003/242
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    References listed on IDEAS

    as
    1. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453, World Scientific Publishing Co. Pte. Ltd..
    2. Merrick Jr., John J., 2001. "Crisis dynamics of implied default recovery ratios: Evidence from Russia and Argentina," Journal of Banking & Finance, Elsevier, vol. 25(10), pages 1921-1939, October.
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    Cited by:

    1. 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.
    2. Mr. Manmohan Singh & Miguel A. Segoviano, 2008. "Counterparty Risk in the Over-The-Counter Derivatives Market," IMF Working Papers 2008/258, International Monetary Fund.
    3. Michael Adler & Jeong Song, 2010. "The behavior of emerging market sovereigns' credit default swap premiums and bond yield spreads," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(1), pages 31-58.
    4. Mr. Manmohan Singh & Karim Youssef, 2010. "Price of Risk: Recent Evidence From Large Financials," IMF Working Papers 2010/190, International Monetary Fund.
    5. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.

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    More about this item

    Keywords

    WP; CDS contract; CDS spread; CDS market; recovery value; credit default swaps; cheapest-to-deliver bonds; CDS equation; CDS insurer; Credit default swap; Bonds; Europe;
    All these keywords.

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