## Are Credit Default Swaps Spreads High in Emerging Markets: An Alternative Methodology for Proxying Recovery Value

_IMF Working Papers, December 1, 2003_

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## Bibliographic details
- Authors: Manmohan Singh
- Published: December 1, 2003
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451875836.001

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### Summary and central claims
- 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.
- 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.
- The note provides evidence from Argentina and Brazil that reveals inconsistency between theory and practice in pricing CDS spreads in EM.
- The note suggests an alternate methodology that links CTD (cheapest-to-deliver) bonds to recovery values assumed in CDS contracts.
- Special features that pertain to CDS contracts (repo specialness, short squeezes by central banks) may also magnify the financial distress of a sovereign.

### Evidence and empirical focus
- Country cases examined: Argentina and Brazil.
- Key empirical observation: CDS spreads can lead sovereign-risk indicators such as the EMBI+ sub-index when a country loses market access.
- Identified gap: Market quotes provide CDS spreads but not the underlying inputs required to calculate theoretical CDS spreads, creating difficulty reconciling observed spreads with model-implied values.

### Methodological contribution
- Proposed alternative methodology: Link CTD (cheapest-to-deliver) bonds to recovery values assumed in CDS contracts.
- Rationale: Using CTD bonds as a proxy provides a way to infer recovery values embedded in market CDS spreads where direct inputs are unobserved.

### Additional factors affecting CDS pricing in EM
- Repo specialness of certain bonds.
- Short squeezes by central banks.
- These special features can magnify financial distress of a sovereign beyond what standard CDS-pricing models may predict.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/are-credit-default-swaps-spreads-high-in-emerging-markets-an-alternative-methodology-for-16977_