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 journalArticlepeer-review

39 Citations (Scopus)

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 languageEnglish
Pages (from-to)19-34
Number of pages16
JournalJournal of Empirical Finance
Volume32
DOIs
Publication statusPublished - 14 Jan 2014
Externally publishedYes

Keywords

  • CDS pricing
  • European debt crisis
  • Heterogeneous beliefs
  • Momentum
  • Sovereign credit risk

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