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Title: Short-term determinants of the idiosyncratic sovereign risk premium: a regime-dependent analysis for European credit default swaps
Authors: Calice, Giovanni
Miao, RongHui
Sterba, Filip
Vasicek, Borek
Keywords: Credit default swaps
Markov switching model
Sovereign risk
State space model
Term premium
Issue Date: 2015
Publisher: © Elsevier
Citation: CALICE, G. ... et al., 2015. Short-term determinants of the idiosyncratic sovereign risk premium: a regime-dependent analysis for European credit default swaps. Journal of Empirical Finance, 33, pp.174-189.
Abstract: This study investigates the dynamics of the sovereign CDS term premium, i.e. difference between 10Y and 5Y CDS spreads. It can be regarded a forward-looking measure of idiosyncratic sovereign default risk as perceived by financial markets. For some European countries this premium featured distinct nonstationary and heteroskedastic pattern during the last years. Using a Markov-switching unobserved component model, we decompose the daily CDS term premium of five European countries into two unobserved 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.
Description: This paper was accepted for publication in the journal Journal of Empirical Finance and the definitive published version is available at http://dx.doi.org/10.1016/j.jempfin.2015.03.018
Version: Accepted for publication
DOI: 10.1016/j.jempfin.2015.03.018
URI: https://dspace.lboro.ac.uk/2134/20698
Publisher Link: http://dx.doi.org/10.1016/j.jempfin.2015.03.018
ISSN: 0927-5398
Appears in Collections:Published Articles (Business School)

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