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Why do investors buy sovereign default insurance?

Patrick Augustin (), Valeri Sokolovski and Marti G. Subrahmanyam

No 540, CFS Working Paper Series from Center for Financial Studies (CFS)

Abstract: We provide a comprehensive analysis of the determinants of trading in the sovereign credit default swaps (CDS) market, using weekly data for single-name sovereign CDS from October 2008 to September 2015. We describe the anatomy of the sovereign CDS market, derive a law of motion for gross positions and their components, and identify the key factors that drive the cross-sectional and time-series properties of trading volume and net notional amounts outstanding. While a single principal component accounts for 54 percent of the variation in sovereign CDS spreads, the largest common factor explains only 7 percent of the variation in sovereign CDS net notional amounts outstanding. Moreover, unlike for CDS spreads, common global factors explain very little of the variation in sovereign CDS trading and net notional amounts outstanding, suggesting that it is driven primarily by idiosyncratic country risk. We analyze several local and regional channels that may explain the trading in sovereign CDS: (a) country-specific credit risk shocks, including changes in a country's credit rating and related outlook changes, (b) the announcement and issuance of domestic and international debt, (c) macroeconomic sentiment derived from conventional and unconventional monetary policy, macro-economic news and shocks, and (d) regulatory channels, such as changes in bank capital adequacy requirements. All our findings suggest that sovereign CDS are more likely used for hedging than for speculative purposes.

Keywords: Banking Regulation; Basel III; Contagion; Credit Default Swaps; OTC; Sovereign Credit Risk; Systemic Risk (search for similar items in EconPapers)
JEL-codes: C1 C5 C68 F34 G12 G13 G15 (search for similar items in EconPapers)
Date: 2016
New Economics Papers: this item is included in nep-ias
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfswop:540

DOI: 10.2139/ssrn.2848944

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