2010‐E‐2

Sovereign Credit Default Swaps: Market Developments
and Factors behind Price Changes
Junnosuke Shino and Kouji Takahashi
Financial Markets Department

April 2010
This paper examines sovereign credit default swaps (CDSs), which have attracted attention since theemergence of the fiscal deficit problem in Greece, with particular focus on the expansion of thesovereign CDS market, the relationship between CDS premiums and fiscal risk variables, and theinternational co‐movement of CDS premiums. The analysis reveals the following: (1) CDS transaction
volume has recently expanded rapidly, mainly reflecting the significant increase in fiscal expenditure insome countries and the heightened awareness of European sovereign risk; (2) however, the degree ofinterrelation between CDS premiums and actual fiscal risk varies by country; and (3) concerns oversovereign risk in some continental European countries may have spilled over to other countries, as seenin the increase in the international co‐movement of CDS premiums among major countries.

Introduction
Since the emergence of the fiscal deficit problem in
Greece1 in the autumn of 2009, sovereign risk has
attracted attention in the global financial market.
As a result, sovereign CDS 2 premiums havewidened, mainly for some continental European
countries (Chart 1).
Chart 1: Sovereign CDS premiums
450

bps

400
350
300

GreecePortugal
United Kingdom
Japan

250
200
150
100

susceptible to investorsʹ speculative motives due tolow market liquidity. It has also been pointed outthat the willingness of a small number of investors
to invest in sovereign risk transactions, rather than
the actual fiscal situation of individual countries,
significantly influences the price dynamics.
Therefore, once investors become aware of acountryʹs sovereign risk and the sovereign CDS
premiums increase, the effects of the increase may
spread to other countries even though there is no
significant change in the fiscal situation. This paper
examines (1) the expansion of the sovereign CDS
market by utilizing basic information such as theamount outstanding of CDSs, (2) the relationshipbetween CDS premiums and fiscal risk variables,and (3) the international co‐movement of CDS
premiums.

500
Jan-07

Jul-07

Jan-08

Jul-08Jan-09Jul-09Jan-10Recent Developments in the Sovereign
CDS Market3

Note: As of February 25, 2010.
Source: Bloomberg.

Some market participants, however, haveexpressed the view that changes in the sovereign
CDS premiums may not accurately reflect acountryʹs actual fiscal situation, because they are

Sovereign CDS transactions have expanded rapidly,
as seen in the increase of more than 30 percent in
the amount outstanding of CDSs over the past year
(Chart 2). This expansion can be attributed to thefollowing factors. First, transactions with more

1

Bank of Japan April 2010

attention to public‐sector risks than private‐sector
ones increased toward the spring of 2009, given theimplementation of large‐scale fiscal stimulus
measures to stabilize the financial sector andeconomic stimulus packages after the failure ofLehman Brothers. And second, activity in thesovereign CDS market increased again, as concerns
over sovereign risk in some European countries
intensified from the autumn of 2009. Meanwhile, arapid recovery in stock prices and a marked
narrowing in corporate bond spreads have been
observed in financial markets around the world,and firmsʹ demand for hedging credit risk has notappeared to increase significantly. Therefore, theamount outstanding of CDSs to hedge the firmsʹ
credit risk has changed little.
In other words, the rapid expansion in thesovereign CDS market over the past year generally
has not spread to the credit‐related transactions of
the corporate sector. It should be noted that evenafter the rapid expansion, the amount outstandingof sovereign CDSs still amounts to less than 20
percent of that of corporate CDSs.
The growth rate of the amount outstanding ofsovereign CDSs by country has risen markedly inJapan, the United States, and the United Kingdom(Chart 3).
In these three countries including Japan, whichface a deterioration in their fiscal balance, market
participants seemed to be more concerned about
the fiscal situation. By region, however, the rankingof these three countries is not high, and thepercentage share of each in the amount outstandingof CDSs registers only around 1 percent (Chart 4).
In this regard, despite the rapid expansion in theamount outstanding of CDSs in Japan, the UnitedStates, and the United Kingdom, such movements
have been within extremely low levels. Therefore,
the expansion does not necessarily mean thatmarket participants are relatively more concerned
about the fiscal situation of these countries
compared to other countries.
Taking into account the fact that investorsʹ
fundamental needs for CDSs are to hedge risks,
there might be a correlation between one countryʹsamount outstanding of public debt including
government bonds and its amount outstanding ofsovereign CDSs. In order to briefly examine thispoint, we compare the share of the amountoutstanding of public debt held by central
governments, including government bonds byregion with that of the amount outstanding ofsovereign CDSs by region, using the data for 26
countries of the member states of the Organisation
for Economic Co‐operation and Development(OECD) for which data are available (Chart 5).
Chart 2: Developments in the CDS markets
1. Growth rates of the amount outstanding of CDSs by
sector
(Feb. 6, 2009-Feb. 5, 2010, % chg.)
0
10
20
30

Sovereign

Corporate

40

30.8

0.6

Total

4.4

2. Amount outstanding of CDSs by sector
16

USD trillions

14

1.66

2.17

12.55

12.63

Feb. 6, 2009

Feb. 5, 2010

12
10
8
6
4
2
0

OthersSovereign

Corporate

Total

Notes: 1. The data for Depository Trust & Clearing Corporation(DTCC) do not necessarily cover all transactions,but could cover nearly 90 percent of transactions.
2. Amount outstanding refers to gross notional values
in U.S. dollars throughout the paper. Gross values
may be regarded as transaction volumes, while net
values may indicate bias of the positions in the markets.
3. "Sovereign" includes central governments andmunicipalities (e.g., state governments in the UnitedStates). "Others" includes mortgage-backed securities(MBSs), CDSs on loans, and others.
Source: Depository Trust & Clearing Corporation.

2

Bank of Japan April 2010

Chart 3: Growth rates of the amount outstanding ofsovereign CDSs by region

Chart 5: Share of the central government debt
and the amount outstanding of CDSs by region(Feb. 6, 2009-Feb. 5, 2010, % chg.)
0 30 60 90 120 150 180

1. Central government debt (2007)
Others4%

Japan
United States
UnitedStates22%

United Kingdom
Europe(excluding Central and Eastern
Europe and the United Kingdom)

Europe(excluding
Central and Eastern
Europe and theUnited Kingdom)
31%

Central and Eastern Europe

Others (including emerging
economies)

Chart 4: Share of top 35 countries in the amountoutstanding of sovereign CDSs

OthersUnitedStates1%

2%
UnitedKingdom

2

4

6

8
10
12
Percentage share

Note: As of February 5, 2010.
Source: Depository Trust & Clearing Corporation.

27%

Europe(excluding
Central and Eastern
Europe and theUnited Kingdom)
56%

Central andEastern Europe
2% 12%
Japan

Note: The shares of 26 countries for which both CDS
outstanding data and central government debt
data are available among 30 OECD member
states (excluding Australia, Canada, Luxembourg,and Switzerland).
Central and Eastern Europe: Austria, the Czech
Republic, Hungary, Poland, and the Slovak Republic.
Others: South Korea, Mexico, New Zealand, and Turkey.
Sources: Depository Trust & Clearing Corporation;
Organisation for Economic Co-operation andDevelopment.

Contributions of top 35
countries:
86.5%

0

Central andEasternEurope2%

2. Amount outstanding of sovereign CDSs (2010)

Source: Depository Trust & Clearing Corporation.

Italy
TurkeyBrazilRussiaMexicoSpain
GreecePhillippines
Germany
Portugal
HungarySouth Korea
Argentina
UkraineVenezuela
FranceAustriaSouth Africa
IrelandIndonesia
United Kingdom
Colombia
China
PolandBelgium
Kazakhstan
Japan
Peru
Malaysia
Thailand
Netherlands
Bulgaria
Romania
SwedenUnited States

Japan
36%

UnitedKingdom
5%

Brazil, Russia, and China

The comparison shows that Japan, the UnitedStates, and the United Kingdom, which account foralmost two‐thirds of the total public debt, hold onlyaround 5 percent of sovereign CDSs. From this, it
can be concluded that so far investors holding
Japanese, U.S., and U.K. government bonds havenot increasingly purchased protection to hedge thedefault risk of the respective government bonds.
It has been pointed out that a significantly highpercentage of Japanese government bonds (JGBs) isheld by Japanese investors while Japanese

3Bank of Japan April 2010

sovereign CDSs are mostly traded by foreign
investors, suggesting that Japanese sovereign CDSs
are rarely used by JGB holders. Given the historicalbackground that U.S. treasury yields have served asa benchmark rate for the evaluation of government
bond yields in emerging economies, it is generally
considered difficult to directly connect U.S.
Treasuries with sovereign risk. This seems to have
served as one factor that limits the trading volumesof U.S. sovereign CDSs.
The amount outstanding of sovereign CDS
contracts in continental European countries andemerging economies represents a high share in the
global market. This can be attributed to thefollowing factors. First, arbitrage transactions onsovereign risk tend to be conducted in thesecountries where the euro convergence trade(trading based on speculation that yield spreads
would narrow which took place in the run‐up to
the euroʹs introduction) 4 and spread trading
between these countriesʹ sovereign bonds and U.S.
Treasuries have been carried out. Second, liquidity
in the government bond markets is relatively low insome of these countries, and CDSs are often used tohedge the risk of fluctuations in government bondprices. And third, investors are not sufficiently
confident about the sound management of fiscal
balances in some emerging economies.

First, we regress the CDS premiums for fourcontinental European countries (Greece, Portugal,
Italy, and Spain), which account for a large amountoutstanding of sovereign CDSs and have attracted
much attention since the autumn of 2009, and thosefor Japan, the United States, and the United
Kingdom, which account for a small amountoutstanding of sovereign CDSs, on their spreads
between the government bond yield and theovernight index swap (OIS) rate, 5 which areconsidered as a fiscal risk premium indicator. 6
When concerns over a countryʹs fiscal situation
heighten, the rate of increase in the government
bond yields outpaces that in the OIS rate, leading toa narrowing of negative spreads (or a widening of
positive spreads). Estimation shows that (1) in thefour continental European countries, R‐squared isgenerally high and the coefficients of determination
for the government bond yield‐OIS spread arestatistically significant; (2) while in Japan, theUnited States, and the United Kingdom, R‐squared
is extremely low and the coefficients are notstatistically significant (Chart 6).
Chart 6: Relationship between CDS premiums andgovernment bond yield-OIS spreads(Weekly change in CDS premium) t =c + α ( weekly change in gov. bond yield − OIS spread ) t
2

Relationship between Sovereign CDS
Premiums and Fiscal Risk Variables
As mentioned above, the amount outstanding ofsovereign CDSs varies by country. An examinationof this point in terms of the price formation
mechanism of and liquidity in the sovereign CDS
market enables the following observations: (1) incountries where the amount outstanding ofsovereign CDSs is at low levels, such as Japan, theUnited States, and the United Kingdom, CDS
premiums are more directly affected by speculativeflows as they are susceptible to the behavior of asmall number of investors; (2) on the other hand,sovereign CDS market liquidity is relatively high incontinental European countries and emerging
economies, and the CDS premiums are more likely
to reflect a countryʹs fiscal risk premiums. In what
follows, we examine this point by using the CDS
premiums and other fiscal risk variables.

α(t -value)

Greece

R
0.80

0.94

(10.12)

Portugal

0.80

1.02

(10.13)

Italy

0.25

0.71

(2.87)

Spain

0.48

1.00

(4.79)(0.82)

Japan

0.03

0.31

United States

0.00

0.05

(0.35)

United Kingdom

0.00

0.04

(0.23)

Notes: 1. Weekly data from August 14, 2009 to February 12, 2010
(number of samples: 27).
2. Shaded areas are statistically significant with 1 percent
critical value.
Sources: Bloomberg; CMA.

Sovereign CDS premiums in Japan, the UnitedStates, and the United Kingdom have recently risen
against the background of the heightened concerns
over sovereign risk, co‐movements of CDS
premiums and government bond yields have notbeen confirmed, and a strong relationship between
CDS premiums and fiscal risk premiums is notfound throughout the estimation period (sinceAugust 2009). This implies that, because the4Bank of Japan April 2010

amount outstanding of sovereign CDSs is at low
levels, CDS premiums seem to be affected by the
behavior of a small number of speculative
investors.
Turning to the four continental European
countries, in Greece and Portugal, where thesovereign CDS premiums are volatile, the relation
between CDS premiums and the government bondyield‐OIS spread is exceptionally strong. Thissuggests that both reflect the fiscal risk premiums.
The ratio of the amount outstanding ofsovereign CDSs to public debt and R‐squared in
Chart 6 shows a moderate positive correlation(Chart 7). Although it is difficult to interpret thisdue to the limited number of samples, it also seems
to imply that when the amount outstanding ofsovereign CDSs decreases relative to the amountoutstanding of government bonds, sovereign CDSs
tend to be affected more by transactions reflecting
demand other than to hedge risks (such as various
arbitrage transactions focused on trading and thedifference between asset prices) or transactions
based on the specific trading motives of certain
investors.7

variable (this analysis is conducted again for thefour continental European countries). The results
suggest a certain level of correlation between thesovereign CDS premiums and yield spreads of eachcountryʹs government bonds over U.S. or German
government bonds (Chart 8). However, the degreeof correlation varies by country, and thus it should
be borne in mind that some degree of error isunavoidable in examining sovereign risks by using
sovereign CDS premiums.
Chart 8: Relationship between CDS premiums andyield spreads over U.S. or German government
bonds(Weekly change in CDS premium) t =c + α ( weekly change in spreads of gov. bonds over
U .S . [or German] gov. bonds ) t

R2

0.8
Greece0.7(t -value)

0.90(10.28)

Portugal

0.76

0.94

(8.92)

Italy

0.23

0.58

(2.72)

Spain

0.43

0.86

(4.38)

Turkey0.46

0.27(4.58)

Brazil0.68

0.43(7.35)

Russia0.26

0.63(2.86)

Mexico0.36

0.49(3.78)

Notes: 1. Weekly data from August 14, 2009 to February 12, 2010
(number of samples: 27).
2. Turkey: 5-year yields and German 5-year yields.
Russia: 9-year yields and German 9-year yields.
Brazil and Mexico: 10-year yields and U.S. 10-year yields.
Others: 10-year yields and German 10-year yields.
3. Shaded areas are statistically significant with 1 percent criticalvalue.

Chart 7: Ratio of the amount outstanding of sovereign
CDSs to public debt and R2 in Chart 6
0.9αGreeceR2
0.81

Portugal

Source: Bloomberg.

0.6
0.5

Spain

0.4
0.3

Italy

0.2

Japan
United States
United Kingdom

0.1
0.0
0

0.1

0.2
0.3
0.4
ratio of the amount outstanding ofsovereign CDSs (2010) to public debt (2007)

Sources: Bloomberg; CMA; Depository Trust & Clearing
Corporation; Organisation for Economic
Co-operation and Development.

A similar analysis is also conducted with regard
to four emerging economies (Turkey, Brazil, Russia,
and Mexico), which account for a large amountoutstanding of sovereign CDSs, by adopting theyield spreads of these countriesʹ government bonds
over the benchmark rate (U.S. or German
government bonds) as a comparable explanatory

International
Co-Movement
Sovereign CDS Premiumsof

The above analyses reveal that the correlation
between sovereign CDS premiums and actual fiscal
risk variables varies from country to country, and astrong correlation cannot always be confirmed. Thisis because developments in sovereign CDS
premiums reflect the behavior of a small number ofinvestors. When investors become aware of acountryʹs sovereign risk (when the investment
attitude of a small number of investors changes)
and the sovereign CDS premiums increase, theeffects of this increase may spread to othercountries. In what follows, we examine theinternational co‐movement of sovereign CDS
premiums via time‐series analysis.
First, we review how the international

5Bank of Japan April 2010

co‐movement of sovereign CDS premiums haschanged. Specifically, we follow the method
described in Diebold and Yilmaz (2009) 8 andestimate the international dependence (theinternational co‐movement 9 computed byaggregating the international dependence) of
sovereign CDS premiums for six major countries
for which long‐term time‐series data are available(Japan, Germany, Greece, Portugal, Spain, andBrazil).
The results of the analysis show that theinternational co‐movement of sovereign CDS
premiums has grown over the past four years,
albeit with some fluctuations (Chart 9). This implies
that sovereign CDS premiums might not onlyreflect the economic fundamentals of the countries
but also be increasingly affected by the globallycommon factors or the effects of other countries.10
Chart 9: International co-movement of sovereign
CDS premiums
70

%

60
50
40
30
20
10
0
Jan-06

Jan-07

Jan-08Jan-09Jan-10Sources: CMA; Bank of Japan.

a shock in one country to other countries. Then we
estimate their contributions to changes in sovereign
CDS premiums. 11 By using this method, thechanges in Japanʹs sovereign CDS premiums can be
explained by (1) globally common factors; 12(2) shocks that occur only in Japan (idiosyncratic
factors); and (3) the spillover effects of an
idiosyncratic shock in other countries to Japan(other factors). For example, if growing concerns
over the stability of the U.S. financial system affect
the global financial markets simultaneously, this isclassified as a globally common factor. On the other
hand, if a shock is first considered as an
idiosyncratic factor in the United States and thisshock influences other countries with a time lag,this is classified as other factors in countries otherthan the United States.
Sovereign CDS premiums recently seem tofollow a similar path in the world as a whole. The
results, however, suggest that the effects of the
globally common shocks have decreased sharply
since the summer of 2009 (Chart 10). The globallycommon factors seem to have played a significant
role given the fact that investors became very risk
averse after the failure of Lehman Brothers andpaid more attention to public‐sector risks thanprivate‐sector ones after the turn of the year 2009.
After that, however, as the massive expansion of
fiscal stimulus measures in order to stabilize thefinancial systems began to level off, the effects ofthe globally common shocks subsided.

Next, we determine whether the growinginternational co‐movement is caused by the
globally common factors or the strong effects ofsovereign CDS premiums for other countries. In
Chart 9, we estimate the international co‐movement
for countries excluding the United States and theUnited Kingdom, as the long‐term time‐series data
are not available. In order to conduct an in‐depth
analysis, we examine sovereign CDS premiums foreight countries including the two just mentioned.
By applying the Kalman filter, we extract thefollowing factors that explain the changes (dailyrate of change) in sovereign CDS premiums:(1) shocks that affect the world simultaneously;(2) idiosyncratic factors (shocks that occur only inthe specific country); and (3) the spillover effects of

6Bank of Japan April 2010

Chart 10: Factors of sovereign CDS premiums
Greece

3.5
3.0
2.5

Portugal
3.0

Global factor
Idiosyncratic factor
Other factors

2.5
2.0

2.0
1.5
1.5
1.0

1.0

0.5

0.5

0.0

0.0
-0.5
Dec-07-0.5
Jun-08Dec-08Jun-09Dec-09Dec-07Spain

2.5

Jun-08Dec-08Jun-09Dec-09Jun-09Dec-09Germany

3.0
2.5

2.0

2.0
1.5

1.5
1.0

1.0

0.5

0.5

0.0
0.0

-0.5
-1.0

-0.5
Dec-07

Jun-08Dec-08Jun-09Dec-07

Dec-09

Japan
3.5

3.0

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0

0.0

-0.5

-0.5
Jun-08Dec-08Dec-08

United Kingdom

3.5

Dec-07

Jun-08Jun-09Dec-07

Dec-09Jun-08

United States

Dec-08Jun-09Dec-09Jun-09Dec-09Brazil
2.0

3.0
2.5

1.5
2.0
1.5

1.0

1.0
0.5

0.5
0.0

0.0

-0.5
-0.5

-1.0
Dec-07

Jun-08Dec-08Jun-09Dec-07

Dec-09Jun-08Dec-08

Note: Natural logarithm of return from the start of December 2007.
Sources: CMA; Bank of Japan.

7

Bank of Japan April 2010

Looking at the developments after the autumn
of 2009, it should be noted that changes in Greeksovereign CDS premiums have been caused largely
by idiosyncratic factors. In a situation where market
participants are aware of the deterioration in thefiscal situation of some countries, Greek sovereign
CDS premiums have widened further due toidiosyncratic factors such as the significant upwardrevision of the outlook for Greeceʹs fiscal deficit in2009. As for sovereign CDS premiums for other
European countries and major countries, an
upward trend of the idiosyncratic factors isobserved while recently other factors have operated
more strongly. Other factors have played asignificant role particularly in the United States andGermany. As sovereign risks have attracted
attention since the emergence of the fiscal deficit
problem in Greece, market participants have begun
to increase their speculative purchases of sovereign
CDS protection for countries other than Greece andconduct arbitrage transactions.
Chart 11: Sovereign CDS premiums in emerging
economies
1,200

bps

Conclusion
The sovereign CDS market is at an early stage of
expansion and has yet to sufficiently reflect theviews of a wide range of market participants. As
market participants invest in sovereign CDSs for avariety of motives, the widening of premiums does
not necessarily indicate the rise in governmentsʹ
fiscal costs and funding costs in a countryʹs private
sector.
Meanwhile, as the cost to take a position in thesovereign CDSs is low compared to that in cash
bonds, sovereign CDSs could quickly reflect themarket participantsʹ views, including longer‐term
projections, on sovereign risks. For example, if
sovereign CDS transactions expand due to concerns
over the fiscal situation, participants in the cash
bond market will become cautious while facing asurge in premiums, which could in turn lead to arise in the actual financing costs. Given these points,
when evaluating developments in the sovereign
CDS market, careful attention should be paid toinvestorsʹ behavior behind the CDS transactions
and its relationship with the government bond cash
market.
13

Philippines
MexicoRussiaBrazilTurkey

1,000
800

1

In October 2009, the outlook for Greeceʹs fiscal deficit in

2009

600

was

revisedupwardsignificantly,

and

this

heightened market participantsʹ concern over a severe
400

deterioration in the fiscal situation, low reliability of fiscal
statistics, and sluggishness in economic conditions.

200

2

0
Jun-04

Jun-05

Jun-06

Jun-07

Jun-08Jun-09Source: CMA.

A CDS is a type of credit derivative and a derivativetransactionthat

involves

purchases

and

sales

of

protection against credit risks of a firm or country. A CDS
that deals with risks of a country is called a sovereign

In Brazil, other factors have not played asignificant role recently, and Brazilian sovereign
CDS premiums have not widened. Reflecting thefirm developments in the economy and therelatively sound fiscal situation, sovereign CDS
premiums for emerging economies other thanemerging Europe, whose amount outstanding ofsovereign CDSs is relatively large, have not shown
any significant widening (Chart 11). The impact of
the fiscal deficit problem in Greece spilled overmainly to Europe, but unlike the case seen in early
2009, it did not spread globally.

CDS.
3

For information on the structure of the CDS market as awhole and types of transactions, see T. Nakayama and Y.
Kawai, ʺCredit Shijo no Hatten ni Kansuru Ichi Kousatsu‐‐ Credit Derivative Shijo wo Chushin ni (An Observationon the Development of the Credit Market ‐‐ Particularly
the Credit Derivatives Market),ʺ Bank of Japan Review
Paper No. 2005‐J‐4, 2005 (in Japanese).

8Bank of Japan April 2010

4

In the euro area, discussion on a scenario in which

The international co‐movement is shown from 1 to 100

9failure to achieve a sound fiscal position results in apercent. When variance of forecast errors is explained

withdrawal from the Economic and Monetary Union

only through the effects of other countries, the(EMU) could invoke a confirmation of default in the CDS

international co‐movement is 100 percent. Conceptually,market and lead to an increase in activity in the sovereign

the international co‐movement in Chart 9 is almost equal

CDS market. A ʺdefaultʺ in the CDS market occurs whento the sum of globally common factors and other factors

CDS contracts are settled following the confirmation of aestimated by using the method in Chart 10.

credit event. It has been pointed out that if a withdrawal

10

from the EMU entails a change in the currency of
government bonds from the euro to the home currency,
this would be confirmed as a restructuring, that is, acredit event.

The possibility cannot be ruled out that economic

fundamentals themselves are correlated globally.
11

They are estimated by applying the method describedin T. Sekine, ʺOn the Recent Management of Monetary
Policy,ʺ a lecture at the Monetary Economics Seminar of

An OIS is an interest rate swap that exchanges the

Kobe University (jointly supported by Japan Society ofuncollateralized overnight call rate over a specified

Monetary Economics), 2009. Specifically, we estimate theperiod and a certain fixed interest rate. For details, see E.

VAR (second lags) by using the ratio of daily change in

Ooka, T. Nagano, and N. Baba, ʺRecent Development oflogarithm of sovereign CDS premiums. Then, using thethe OIS (Overnight Index Swap) Market in Japan,ʺ Bank

Kalman filter, we decompose the errors and extract theof Japan Review Paper No. 2006‐E‐4, 2006.

globally common factors and idiosyncratic factors. For

5

An increase in the fiscal risk premium exerts downward

details, see F. X. Diebold, C. Li, and V. Z. Yue, ʺGlobalpressure on the relative advantage of government bonds

Yield Curve Dynamics and Interactions: A Dynamic

in portfolio selection and leads to a widening in the

Nelson‐Siegel Approach,ʺ Journal of Econometrics, 146 (2),government bond yield‐OIS spread. It should be noted

2008, pp. 351‐363, or K. Takahashi, ʺKokusai Kinʹyu Shijo

6

that the heightening of concerns over the fiscal situationnothrough a rise in inflation expectations might be reflected

Financial Markets) (tentative title),ʺ Bank of Japan Review

in not only government bond yields but also the OIS rate.

Series (forthcoming, in Japanese).

The

12

government

bondyield‐OIS

spreadincludesSougorenkan(Correlation

in

the

International

Taking into account the time‐series data, the globally

premiums on the risk of price volatility (term premiums),

common factors seem to be strongly influenced bywhich reflects not only fiscal factors but also various

investorsʹ risk appetite. For details, see K. Takahashi,

other factors.

ʺKokusai Kinʹyu Shijo no Sougorenkan (Correlation in the7

For more information on motives for trading, see theInternational Financial Markets) (tentative title),ʺ Bank ofFinancial Markets Department, Bank of Japan, Financial

Japan Review Series (forthcoming, in Japanese).

Markets Report, February 2010.

13

8

In this paper, in order to calculate the internationalco‐movement of CDS premiums, we first estimate thevector autoregression (VAR). Then, we conduct a
Cholesky decomposition on errors to distinguish theshocks. We estimate the international dependence ofsovereign CDS premiums via variance decomposition often‐period‐ahead
co‐movementisforecast

errors.

computedbyThe

international

aggregating

theinternational dependence. For details, see F. Diebold andBank of Japan Review is published by the Bank of Japan to
explain recent economic and financial topics for a wide rangeof readers. This report, 2010-E-2, is a translation of the original
Japanese issue, Bank of Japan Review Paper No. 2010-J-4,
published in April 2010. The views expressed in the Review arethose of the authors and do not necessarily represent those of
the Bank of Japan. If you have comments, questions, orrequests for hard copies, please contact Financial Markets
Analysis, Financial Markets Department (Tel: +81-3-3279-1111[ext. 2810]). Bank of Japan Review E-series and Bank of Japan
Working Paper E-series can be obtained through the Bank ofJapan's web site (http://www.boj.or.jp).

K. Yilmaz, ʺMeasuring Financial Asset Return andVolatility Spillovers, with Application to Global Equity
Markets,ʺ Economic Journal, 119 (5), 2009, pp. 158‐171.

9Bank of Japan April 2010