Sovereign CDS and bond pricing dynamics in the Euro-area
By: Giorgia Palladini, Richard Portes
Contributors: Portes, Richard; National Bureau of Economic Research
Series: NBER working paper series -- working paper 17586; Working paper series (National Bureau of Economic Research : Online) -- working paper no. 17586.
Publisher: National Bureau of Economic Research
Published: 2011
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Description: "This analysis tests the price discovery relationship between sovereign CDS premia and bond yield spreads on the same reference entity.  The theoretical no-arbitrage relationship between the two credit spreads is confronted with daily data from six Euro-area countries over the period 2004-2011.  As a first step, the supposed non stationarity of the two series is verified.  Then, we examine whether the non-stationary CDS and bond spreads series are bound by a cointegration relationship.  Overall the cointegration analysis confirms that the two prices should be equal to each other in equilibrium, as theory predicts.  Nonetheless the theoretical value [1, -1] for the cointegrating vector is rejected, meaning that in the short run the cash and synthetic market's valuation of credit risk differ to various degrees.  The VECM analysis suggests that the CDS market moves ahead of the bond market in terms of price discovery.  These findings are further supported by the Granger Causality Test: for most sovereigns in the sample, past values of CDS spreads help to forecast bond yield spreads.  Short-run deviations from the equilibrium persist longer than it would take for participants in one market to observe the price in the other.  That is consistent with the hypothesis of imperfections in the arbitrage relationship between the two markets"--National Bureau of Economic Research web site.
Notes: Title from PDF file as viewed on 1/12/2012.

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