Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/154150
Authors: 
Calice, Giovanni
Miao, RongHui
Štěrba, Filip
Vašíček, Bořek
Year of Publication: 
2014
Series/Report no.: 
ECB Working Paper 1717
Abstract: 
This study investigates the dynamics of the sovereign CDS term premium for five European countries. The CDS term premium can be regarded as a forward-looking measure of idiosyncratic sovereign default risk as perceived by financial markets. Using a Markov-switching unobserved component model, we decompose the daily CDS term premium into two 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.
Subjects: 
credit default swaps
markov switching model
sovereign risk
state space model
term premium
JEL: 
G01
G15
G21
G24
ISBN: 
978-92-899-1125-2
Document Type: 
Working Paper

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