Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market

Carl Chiarella; Saskia ter Ellen; Xue Zhong He; Eliza Wu

doi:10.1016/j.jempfin.2014.11.003

Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market

Carl Chiarella, Saskia ter Ellen^*, Xue Zhong He, Eliza Wu

^*Corresponding author for this work

Research output: Contribution to Journal › Article › Academic › peer-review

Abstract

This paper proposes a model for credit default swap (CDS) spreads under heterogeneous expectations to explain the escalation in sovereign European CDS spreads and the widening variations across European sovereigns following the Global Financial Crisis (GFC). In our model, investors believe that sovereign CDS spreads are determined by country-specific fundamentals and momentum. By estimating the model we find evidence that, while some of the recent movements in sovereign CDS spreads can be explained by deteriorating fundamentals for core European Union (EU) countries, momentum has also played a destabilizing role since the GFC in all sovereign credit markets studied.

Original language	English
Pages (from-to)	19-34
Number of pages	16
Journal	Journal of Empirical Finance
Volume	32
DOIs	https://doi.org/10.1016/j.jempfin.2014.11.003
Publication status	Published - 14 Jan 2014
Externally published	Yes

Bibliographical note

Publisher Copyright:
© 2014 Elsevier B.V.

Funding

This paper was partly written while Saskia ter Ellen was visiting University of Technology Sydney (UTS) Business School. We would like to thank the editor, two anonymous referees, Remco Zwinkels, seminar participants at the University of Technology Sydney, University of Groningen, VU University Amsterdam, Norges Bank, and Australian National University, and participants of the 2013 Auckland Finance Meeting, the 2013 meeting of the Society of Nonlinear Dynamics and Econometrics (SNDE), the Southampton International Conference on the Global Financial Crisis, the 11th INFINITI conference on “The Financial Crisis, Integration and Contagion” and the “Nederlandse Economen Dag” (Dutch Economists Day) for their useful comments. Financial support from the Australian Research Council (ARC) for He under Discovery Grant ( DP130103210 ) is gratefully acknowledged. The views expressed are those of the authors and do not necessarily reflect those of Norges Bank. The authors alone are responsible for any errors that may remain.

Funders	Funder number
Australian Research Council	DP130103210

Keywords

CDS pricing
European debt crisis
Heterogeneous beliefs
Momentum
Sovereign credit risk

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title = "Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market",

abstract = "This paper proposes a model for credit default swap (CDS) spreads under heterogeneous expectations to explain the escalation in sovereign European CDS spreads and the widening variations across European sovereigns following the Global Financial Crisis (GFC). In our model, investors believe that sovereign CDS spreads are determined by country-specific fundamentals and momentum. By estimating the model we find evidence that, while some of the recent movements in sovereign CDS spreads can be explained by deteriorating fundamentals for core European Union (EU) countries, momentum has also played a destabilizing role since the GFC in all sovereign credit markets studied.",

keywords = "CDS pricing, European debt crisis, Heterogeneous beliefs, Momentum, Sovereign credit risk",

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AU - Chiarella, Carl

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AU - He, Xue Zhong

AU - Wu, Eliza

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N2 - This paper proposes a model for credit default swap (CDS) spreads under heterogeneous expectations to explain the escalation in sovereign European CDS spreads and the widening variations across European sovereigns following the Global Financial Crisis (GFC). In our model, investors believe that sovereign CDS spreads are determined by country-specific fundamentals and momentum. By estimating the model we find evidence that, while some of the recent movements in sovereign CDS spreads can be explained by deteriorating fundamentals for core European Union (EU) countries, momentum has also played a destabilizing role since the GFC in all sovereign credit markets studied.

AB - This paper proposes a model for credit default swap (CDS) spreads under heterogeneous expectations to explain the escalation in sovereign European CDS spreads and the widening variations across European sovereigns following the Global Financial Crisis (GFC). In our model, investors believe that sovereign CDS spreads are determined by country-specific fundamentals and momentum. By estimating the model we find evidence that, while some of the recent movements in sovereign CDS spreads can be explained by deteriorating fundamentals for core European Union (EU) countries, momentum has also played a destabilizing role since the GFC in all sovereign credit markets studied.

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KW - European debt crisis

KW - Heterogeneous beliefs

KW - Momentum

KW - Sovereign credit risk

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Fear or fundamentals? Heterogeneous beliefs in the European sovereign CDS market

Abstract

Bibliographical note

Funding

Keywords

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