Short-term determinants of the idiosyncratic sovereign risk premium: a regime-dependent analysis for european credit default swaps

Bořek Vašíček (), Giovanni Calice, RongHui Miao and Filip Štěrba

No 1717, Working Paper Series from European Central Bank

Abstract: This study investigates the dynamics of the sovereign CDS term premium for five European countries. The CDS term premium can be regarded as a forward-looking measure of idiosyncratic sovereign default risk as perceived by financial markets. Using a Markov-switching unobserved component model, we decompose the daily CDS term premium into two components of statistically different nature and link them in a vector autoregression to various daily observed financial market variables. We find that such decomposition is vital for understanding the short-term dynamics of this premium. The strongest impacts can be attributed to CDS market liquidity, local stock returns, and overall risk aversion. By contrast, the impact of shocks from the sovereign bond market is rather muted. Therefore, the CDS market microstructure effect and investor sentiment play the main roles in sovereign risk evaluation in real time. Moreover, we also find that the CDS term premium response to shocks is regime-dependent and can be ten times stronger during periods of high volatility. JEL Classification: G01, G15, G21, G24

Keywords: credit default swaps; markov switching model; sovereign risk; state space model; term premium (search for similar items in EconPapers)
Date: 2014-08
New Economics Papers: this item is included in nep-eec
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Related works:
Journal Article: Short-term determinants of the idiosyncratic sovereign risk premium: A regime-dependent analysis for European credit default swaps (2015)
Working Paper: Short-Term Determinants of the Idiosyncratic Sovereign Risk Premium: A Regime-Dependent Analysis for European Credit Default Swaps (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20141717

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