Sovereign debt renegotiation and credit default swaps

Juliana Salomao

Journal of Monetary Economics, 2017, vol. 90, issue C, 50-63

Abstract: A credit default swap (CDS) contract provides insurance against default. This paper incorporates the contract into a sovereign default model and demonstrates that the existence of a CDS market results in lower default probability, higher debt levels, and lower financing costs for the country. Uncertainty over the insurance payout when the debt is renegotiated explains why in the data, as the output declines, the CDS spread becomes lower than the bond spread. Finally, my results show that the 2012 CDS naked ban, that decreased the levels of CDS for European countries, is a welfare reducing policy.

Keywords: Credit default swaps; Sovereign default; Debt renegotiation; Naked ban; Negative basis (search for similar items in EconPapers)
JEL-codes: F34 F42 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:90:y:2017:i:c:p:50-63

DOI: 10.1016/j.jmoneco.2017.06.005

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