The impact of the recent financial crisis on Eurozone sovereign credit default swap spreads

Paola Z Zerilli, Christopher Baum

Research output: Working paper

Abstract

This study evaluates the effects of the recent financial crisis on an important class
of debt instruments: sovereign issues of Eurozone borrowers. Challenges to the
stability of the Euro from threats of default by several Eurozone countries have
raised serious concerns and led to unprecedented policy responses. We propose
to study these effects by evaluating the risk premia embedded in sovereign credit
default swap (CDS) spreads during periods of financial turmoil. These instruments
provide insurance to their buyers, payable in the event of default. Their spreads
over riskless instruments and spreads within the Eurozone CDS universe provide
direct indications of market participants' valuation of risk associated with the
underlying sovereign debt. Our methodology estimates the frequency of default
events in order to analyse how perceptions of default risk have affected the
demand for insurance on short-term vs. long-term debt instruments.
Original languageEnglish
Publication statusIn preparation - 2012

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