Abstract
This paper examines the relationship between sovereign credit default swaps (CDS) and sovereign rating changes of European countries. To this aim, a new estimator is introduced which merges mixed data sampling (MIDAS) with probit regression. Simulations show that the estimator has good properties in finite sample. Also, I investigate a bootstrap procedure introduced by Ghysels et al. (2007), which should be able to handle significance testing in a MIDAS setting. The bootstrap has
good size but low power. For the empirical analysis I use sovereign CDS data for 22 EU countries trying to correlate sovereign downgrades with sovereign CDS premiums. Overall the CDS data and the ratings are in most cases significantly positively correlated. Therefore, Credit Rating Agencies (CRA) and financial markets are generally agreeing on the implied default probability of sovereign nations. Also, CDS prices are expecting downgrades in advance in the majority of investigated
datasets. However, this does not mean that a default probability can be extracted from raw CDS prices. Instead, by using a MIDAS estimator, I significantly reduce the amount of noise in the data. Therefore, CRAs are still providing important information to financial markets.
good size but low power. For the empirical analysis I use sovereign CDS data for 22 EU countries trying to correlate sovereign downgrades with sovereign CDS premiums. Overall the CDS data and the ratings are in most cases significantly positively correlated. Therefore, Credit Rating Agencies (CRA) and financial markets are generally agreeing on the implied default probability of sovereign nations. Also, CDS prices are expecting downgrades in advance in the majority of investigated
datasets. However, this does not mean that a default probability can be extracted from raw CDS prices. Instead, by using a MIDAS estimator, I significantly reduce the amount of noise in the data. Therefore, CRAs are still providing important information to financial markets.
Original language | English |
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Place of Publication | Maastricht |
Publisher | Maastricht University, Graduate School of Business and Economics |
DOIs | |
Publication status | Published - 1 Jan 2014 |
Publication series
Series | GSBE Research Memoranda |
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Number | 038 |