On the Reliability of a Credit Default Swap Contract during the EMU Debt Crisis

Petra Buzkova () and Milos Kopa
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Petra Buzkova: Institute of Economic Studies, Charles University, Prague
Milos Kopa: Department of Probability and Mathematical Statistics, Faculty of Mathematics and Physics, Charles University, Prague

Czech Journal of Economics and Finance (Finance a uver), 2016, vol. 66, issue 6, 510-538

Abstract: The reliability of the credit default swap market was questioned repeatedly during the EMU debt crisis. This article examines whether this development influenced sovereign EMU CDS prices in general. We regress the CDS market price on a model risk neutral CDS price obtained from an adopted reduced form valuation model in the 2009–2013 period. We look for a breakpoint in the single-equation and multi-equation econometric models in order to show the changes in relationships between the CDS market and model prices. Our results differ according to the risk profile of a country. We find that in the case of riskier countries, the relationship between the market and model price changed when market participants started to question the ability of CDS contracts to protect their buyers. Specifically, it weakened after the change. In the case of less risky countries, the change happened earlier and the effect of a weakened relationship is not observed.

Keywords: credit default swap; debt crisis; Chow breakpoint test; reduced form valuation model; seemingly unrelated regression (search for similar items in EconPapers)
JEL-codes: C22 G01 G12 (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:fau:fauart:v:66:y:2016:i:6:p:510-538

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