Are Credit Default Swaps Spreads High in Emerging Markets: An Alternative Methodology for Proxying Recovery Value
December 1, 2003
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Summary
In times of distress when a country loses access to markets, there is evidence that credit default swap (CDS) spreads are a leading indicator for sovereign risk than the EMBI+ sub-index for the country. However, it is not easy to discern the variables that determine the level of CDS spreads in Emerging Markets (EM); traders only quote the CDS spreads and not the inputs that are required to calculate such spreads. This note provides some evidence from Argentina and Brazil that reveals inconsistency between theory and practice in pricing CDS spreads in EM. This note suggests an alternate methodology that links CTD (cheapest-to-deliver) bonds to recovery values assumed in CDS contracts. Furthermore, special features that pertain to CDS contracts (repo specialness, short squeezes by central banks) may also magnify the financial distress of a sovereign.
Subject: Bonds, Credit default swap, Financial institutions, Money
Keywords: Bonds, CDS contract, CDS equation, CDS insurer, CDS market, CDS spread, cheapest-to-deliver bonds, Credit default swap, credit default swaps, Europe, recovery value, WP
Pages:
8
Volume:
2003
DOI:
Issue:
242
Series:
Working Paper No. 2003/242
Stock No:
WPIEA2422003
ISBN:
9781451875836
ISSN:
1018-5941
