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

Didier Cossin () and Gero Jung
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Didier Cossin: IMD International and FAME
Gero Jung: Graduate Institute of International Studies

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

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.

Keywords: Credit Default Swaps; Sovereign Risk; Financial Crises; Event Study (search for similar items in EconPapers)
JEL-codes: F34 G13 G15 (search for similar items in EconPapers)
Date: 2005-03
New Economics Papers: this item is included in nep-fin and nep-sea
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Citations: View citations in EconPapers (3)

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