Are the sovereign CDS premia sound estimators of the stock market returns?Evidence from the Eurozone

  1. Ana Navarrete Wic 1
  2. Filippo Di Pietro 2
  3. José Luis Martín Marín 1
  1. 1 Universidad Pablo de Olavide
    info

    Universidad Pablo de Olavide

    Sevilla, España

    ROR https://ror.org/02z749649

  2. 2 Universidad de Sevilla
    info

    Universidad de Sevilla

    Sevilla, España

    ROR https://ror.org/03yxnpp24

Journal:
Revista de métodos cuantitativos para la economía y la empresa

ISSN: 1886-516X

Year of publication: 2018

Volume: 25

Pages: 130-155

Type: Article

DIALNET GOOGLE SCHOLAR lock_openOpen access editor

More publications in: Revista de métodos cuantitativos para la economía y la empresa

Abstract

In this paper, we explore the interconnection and existing relationships between the Sovereign Credit Default Swaps (henceforth, CDS) and the stock markets of the main European countries. Thus, the goal of this paper is to test if the CDS premia can predict the stock market returns of the most relevant economies within the Eurozone, so that, they serve as advanced indicators like mechanisms of price transmission. For this purpose, we apply the Granger Causality test to analyze ten main European stock markets from 2004 to 2016 by using daily data. Our hypothesis is proved to work for the largest economies with liquid CDS markets, whereas the transmission mechanism between CDS and stock prices is not so evident for the smallest ones.

Bibliographic References

  • Acharya, V.V., Steffen, S., (2013). The “greatest” carry trade ever? Understanding Eurozone bank risks. CEPR Discussion Paper, nº 9432.
  • Acharya, V.V., Drechsler, I., Schnabl, P., (2011). A Pyrrhic victory? Bank bailouts and sovereign credit risk. CEPR Discussion Paper, nº 8679.
  • Adrian, T., Brunnermeier, MK, (2008). CoVar. Federal Reserve Bank of New York, Staff Report, nº 348 (September).
  • Aizemann, J., Hutchinson, MM, Jinjarak, N., (2011). What is the risk of European sovereign debt default? Fiscal space, CDS spread and market princing of risk. NBER Working paper nº 17407.
  • Allen, WA., Moessner, R., (2013). The liquidity consequences of the euro area sovereign debt crisis. BIS. Working paper nº 1302.
  • Ang, A., Longstaff, F.A, (2013). Systemic sovereign credit risk: Lessons from the U.S. and Europe. Journal of Monetary Economics, 60:493-510.
  • Apergis, N., Ajmi, A.N. (2015). Systemic Sovereign Risk and Asset Prices: Evidence from the CDS Markets stressed European Economics and nonlinear causality tests. Journal of Economics and Finance, 65:127-143.
  • Badillo, R., Belaire, J., Reverte, C., (2010). Spurius rejections by Dickey-Fuller test in the presence of an endogenously determined break under the null. Revista de Métodos Cuantativos para Economía y la Empresa, Vol. 9. U.P.O: 6-12.
  • Bekaert, G., Ehrmann, M., Fratzscher, M., Mehl, A., (2013). Global crisis and equity market contagion. NBER Working Paper, nº 17121.
  • Blanco, R., Brennan, S., March, I., (2005). An empirical analysis of the dynamic relation between investment-grade bonds and credit default swaps. The Journal of Finance: 18-32.
  • Borgy, V., Laubach, T., Mésonnier, JS., Renne, JP., (2011). Fiscal sustainability, default risk and Euro area sovereign bond spreads markets. Banque de France. Working paper nº 350.
  • Brock, W.A., Hommes, C.H., Wagner, F.O.O, (2009). More hedging instruments may destabilize markets. Journal of Economic Dynamics and Control, 33:1912-1928.
  • Brooks, C., (2008). Introductory Econometrics for Finance, (Second Edition ed.). Cambridge University Press.
  • Brunnermeier, M., Pedersen, L.H. (2009). Market Liquidity and Funding Liquidity. The Review of Financial Studies: 11-21.
  • Brunnermeier, M., Crockett, C., Goodhart, C., Persaud, A., Shin, H., (2009). The fundamental principles of financial regulation. ICMB-CEPR Geneva Report on the World Economy series.
  • Coimbra, N., (2014). Sovereign at risk: a dynamic model of sovereign debt and banking leverage. London Business School. Departament of Economics.
  • Dickey, D.A. and Fuller, W.A. (1981). Likelihood ratio statistics for autoregressive time series with a unit root. Journal of the Econometric Society, 49. 1057-1072.
  • Dieckmann, S., Plank, T., (2012). Default risk of advanced economies: an empirical analysis of credit default swaps during the financial crisis. Review of Finance, 16: 903-934.
  • Engle, R.F. and Granger, C.W.J., (1991). In long-run economic relationships: Readings in cointegration (Eds). Oxford University Press: 267-276.
  • Favero, C., Missale, A., (2012). Sovereign spreads in the Euro area: Wich prospects for a Eurobond?. Economic Policy, 27:231-273.
  • Fong, T., Wong, A., (2011). Analysing interconnectivity among economies. Emerging Markets Review, 12: 432-442.
  • Gabriel, V. (2015). Sensitivity, persistence and asymmetric effects in international stock market volatility during the global financial crisis. Revista de Métodos Cuantativos para Economía y la Empresa, Vol. 19. U.P.O: 44-45.
  • Geanakoplos, J. (2010). Solving the present crisis and managing the leverage cycle. Federal Reserve Bank of New York Economic Policy Review: 101-131.
  • Gennaioli, N., Martin, A., Rossi, S. (2010). Sovereign default, domestic banks and financial institutions. CEPR Discussion Papers, nº 7955.
  • Glynn, J., Perera, N., Verma, R., (2007). Unit root test and structural breaks: A survey with applications. Revista de Métodos Cuantitativos para la Economía y la Empresa. Vol. 3. U.P.O: 65-66.
  • Granger, C.W.J., (1969). Investigating causal relations by econometric models and cross-spectral methods. Journal of the Econometric Society. 424-438
  • Hatemi, J.A. (2012). Asymmetric causality test with an application. Empirical Economics, 43: 447-456.
  • Huizinga, H., Demirguc-Kunt, A., (2013). Are banks too big to fail or too big to save? International evidence from equity prices and CDS spreads. Journal of Banking & Finance, 37: 875-894.
  • Koy, A., (2017). International Credit Default Swaps market during European Crisis. Springer.
  • MacKinnon, J.G., (1991). Critical values for cointegration tests. Queen´s Economics Department, Working Paper nº 1227: 2-4.
  • Sato, J.R., Morettin, P.A., Arantes, P.R., Amaro J.R. (2007). Wavelet based time-varying vector autoregressive modelling. Computational Statistics & Data Analysis, 51: 5847-5866.
  • Simsek, A. (2013). Speculation and risk sharing with new financial assets. Quarterly Journal of Economics, 128:1365-1396.
  • Zhu, H., (2006). An empirical comparison of credit spreads between the bond market and credit default swaps market. Journal of Financial Services: 17-21.
Data source: Dialnet