CDS Pricing and Elections in Emerging Markets

Christopher Balding ()

Journal of Emerging Market Finance, 2011, vol. 10, issue 2, 121-173

Abstract: To study the role of elections in financial market instability, we focus on the role of credit risk pricing during elections from 2004 to 2007 in 13 emerging market economies. We use a unique dataset of daily credit default swap (CDS) pricing, with standard macroeconomic controls, to study the role of elections in prompting financial market instability and contagion. Sovereign CDS pricing provides a number of advantages in understanding emerging market instability of previous studies. First, the daily data allows a greater level of specificity than was used in previous credit market and political studies. Second, even though sovereign credit conditions change slowly, CDS pricing changes daily, reflecting sentiment or forward-looking beliefs. Third, the CDS allows us to focus on the perceived public credit risk of an election and the incoming government. Our study reveals a number of unique findings. First, investors price in additional risk for elections regardless of party, incumbency or size of win. Second, long- and short-term investors price risk very differently, with 1-year CDS investors reacting much more strongly to election risk, causing the overall spread between 10- and 1-year swaps to narrow. Third, our results provide continued support for the theory of investor herding in international financial markets, and a focus on a small number of economic variables in determining sovereign creditworthiness. Investors do not study the relative risk factors as much as price in structural risk by the existence of definable benchmarks like elections.

Keywords: JEL Classification: D72; JEL Classification: F34; JEL Classification: G15; Emerging markets; credit default swaps; sovereign debt; elections (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:sae:emffin:v:10:y:2011:i:2:p:121-173

DOI: 10.1177/097265271101000201

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