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CDS Spreads in European Periphery: Some Technical Issues to Consider

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  • Mr. Manmohan Singh
  • Mr. Mohsan Bilal

Abstract

This paper looks at some technical issues when using CDS data, and if these are incorporated, the analysis or regression results are likely to benefit. The paper endorses the use of stochastic recovery in CDS models when estimating probability of default (PD) and suggests that stochastic recovery may be a better harbinger of distress signals than fixed recovery. Similarly, PDs derived from CDS data are risk-neutral and may need to be adjusted when extrapolating to real world balance sheet and empirical data (e.g. estimating banks losses, etc). Another technical issue pertains to regressions trying to explain CDS spreads of sovereigns in peripheral Europe - the model specification should be cognizant of the under-collateralization aspects in the overall OTC derivatives market. One of the biggest drivers of CDS spreads in the region has been the CVA teams of the large banks that hedge their exposure stemming from derivative receivables due to non-posting of collateral by many sovereigns (and related entities).

Suggested Citation

  • Mr. Manmohan Singh & Mr. Mohsan Bilal, 2012. "CDS Spreads in European Periphery: Some Technical Issues to Consider," IMF Working Papers 2012/077, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2012/077
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    References listed on IDEAS

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    1. Jeffery D Amato, 2005. "Risk aversion and risk premia in the CDS market," BIS Quarterly Review, Bank for International Settlements, December.
    2. Carolyne Spackman & Mr. Manmohan Singh, 2009. "The Use (and Abuse) of CDS Spreads During Distress," IMF Working Papers 2009/062, International Monetary Fund.
    3. John C. Hull, 2009. "The Credit Crunch of 2007: What Went Wrong? Why? What Lessons Can be Learned?," World Scientific Book Chapters, in: Douglas D Evanoff & Philipp Hartmann & George G Kaufman (ed.), The First Credit Market Turmoil Of The 21st Century Implications for Public Policy, chapter 11, pages 161-174, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Tola, Albi & Wälti, Sébastien, 2015. "Deciphering financial contagion in the euro area during the crisis," The Quarterly Review of Economics and Finance, Elsevier, vol. 55(C), pages 108-123.
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    3. International Monetary Fund, 2012. "Euro Area Policies: 2012 Article IV Consultation: Selected Issues Paper," IMF Staff Country Reports 2012/182, International Monetary Fund.
    4. 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.
    5. López-Espinosa, Germán & Moreno, Antonio & Rubia, Antonio & Valderrama, Laura, 2017. "Sovereign tail risk," Journal of International Money and Finance, Elsevier, vol. 79(C), pages 174-188.

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