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The behavior of emerging market sovereigns' credit default swap premiums and bond yield spreads
Author(s) -
Adler Michael,
Song Jeong
Publication year - 2010
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.408
Subject(s) - credit default swap , bond , economics , bond market , monetary economics , emerging markets , credit risk , credit default swap index , corporate bond , yield (engineering) , financial economics , credit valuation adjustment , actuarial science , finance , materials science , credit reference , metallurgy
We test whether credit risk for Emerging Market Sovereigns is priced equally in the credit default swap (CDS) and bond markets. The parity relationship between CDS premiums and bond yield spreads (BYS), that was tested and largely confirmed in the literature, is mostly rejected. Prices below par can result in positive basis, i.e. CDS premiums that are greater than BYS and vice versa. To adjust for the non‐par price, we construct the BYS implied by the term structure of CDS premiums for various maturities. We are able to restore the parity relation and confirm the equivalence of credit risk pricing in the CDS and bond markets for many countries that have bonds with non‐par prices and time varying credit quality. We detect non‐parity even after the adjustment mainly in countries in Latin America, where the bases are larger than the bid–ask spreads in the market. We also find that the repo rates of bonds decrease around episodes of credit quality deterioration, which helps the basis remain positive. Copyright © 2009 John Wiley & Sons, Ltd.