Skip to main content Accessibility help
×
×
Home

THE “DARK SIDE” OF CREDIT DEFAULT SWAPS INITIATION: A CLOSE LOOK AT SOVEREIGN DEBT CRISES

  • Hippolyte Wenéyam Balima (a1), Jean-Louis Combes (a2) and Alexandru Minea (a2) (a3)
Abstract

We examine the effect of sovereign credit default swaps (CDS) trading initiation on the occurrence of sovereign debt crises (SDC). Estimations on a large sample of 141 countries for 1980–2013 reveal that, by affecting the fiscal stance, CDS initiation increases by around 1.5 percentage points on average the probability of SDC in countries with CDS compared to the other countries. This result holds for different robustness tests and is found to be stronger for developing countries, for countries with initial lower creditworthiness, and when the degrees of central bank independence and public sector transparency are low. Consequently, compared to existing work emphasizing favorable effects, CDS trading initiation is found to have adverse effects, by increasing the occurrence of SDC. These opposite effects should fuel the literature on measuring the consequences of CDS trading initiation, and its design and implementation from a policy perspective.

Copyright
Corresponding author
Address correspondence to: Alexandru Minea, Université Clermont Auvergne, CNRS, IRD, CERDI, F-63000 Clermont-Ferrand, France; e-mail: alexandru.minea@uca.fr
Footnotes
Hide All

We are particularly grateful to Blake Phillips for sharing his database. We thank Makram El-Shagi and two anonymous referees for valuable comments on a previous version. We are indebted to Xavier Debrun, Jerzy Konieczny, Camelia Turcu, Marcel Voia, and participants at the 3rd HenU/INFER Workshop on Applied Macroeconomics (Kaifeng, China) and the RCEA Macro-Money-Finance Workshop “Advances in Macroeconomics and Finance” (Rimini, Italy) for helpful remarks. We thank the ANR (Agence Nationale de la Recherche) for their financial support through the “Grand Emprunt” and the LABEX IDGM+ (ANR-10-LABX-14-01) mechanism. Usual disclaimers apply.

Footnotes
References
Hide All
Abadie, A. and Imbens, G. W. (2006) Large sample properties of matching estimators for average treatment effects. Econometrica 74, 235267.
Abadie, A. and Imbens, G. W. (2011) Bias corrected matching estimators for average treatment effects. Journal of Business and Economic Statistics 29, 111.
Acharya, V., Drechsler, I. and Schnabl, P. (2014) A pyrrhic victory? Bank bailouts and sovereign credit risk. Journal of Finance 69, 26892739.
Acharya, V. V. and Johnson, T. C. (2007) Insider trading in credit derivatives. Journal of Financial Economics 84, 110141.
Alesina, A. and Weder, B. (2002) Do corrupt governments receive less foreign aid? American Economic Review 92, 11261137.
Ammer, J. and Cai, F. (2011) Sovereign CDS and bond dynamics in emerging markets: Does the cheapest-to-deliver option matter? Journal of International Financial Markets, Institutions and Money 21, 369387.
Arce, O., Mayordomo, S. and Peña, J. Ignacio (2013) Credit-risk valuation in the sovereign CDS and bonds markets: Evidence from the euro area crisis. Journal of International Money and Finance 35, 124145.
Ashcraft, A. B. and Santos, J. A. C. (2009) Has the CDS market lowered the cost of corporate debt? Journal of Monetary Economics 56, 514523.
Balima, W. H., Combes, J.-L. and Minea, A. (2016) Bond markets initiation and tax revenue mobilization in developing countries. Southern Economic Journal 83, 550572.
Balima, W. H., Combes, J.-L. and Minea, A. (2017) Sovereign debt risk in emerging market economies: Does inflation targeting adoption make any difference? Journal of International Money and Finance 70, 360377.
Blanco, R., Brennan, S. and Marsh, I. (2005) An empirical analysis of the dynamic relation between investment-grade bonds and credit default swaps. Journal of Finance 60, 22552281.
Bolton, P. and Oehmke, M. (2011) Credit default swaps and the empty creditor problem. Review of Financial Studies 24, 26172655.
Broto, C. and Pérez-Quirós, G. (2015) Disentangling contagion among sovereign CDS spreads during the European debt crisis. Journal of Empirical Finance 32, 165179.
Brunner, A. and Krahnen, J. P. (2008) Multiple lenders and corporate distress: Evidence on debt restructuring. Review of Economic Studies 75, 415442.
Calice, G., Chen, J. and Williams, J. (2013) Liquidity spillovers in sovereign bond and CDS markets: An analysis of the Eurozone sovereign debt crisis. Journal of Economic Behavior & Organization 85, 122143.
Che, Y.-K. and Sethi, R. (2014) Credit market speculation and the cost of capital. American Economic Journal: Microeconomics 6, 134.
Crowe, C. and Meade, E. (2008) Central bank independence and transparency: Evolution and effectiveness. European Journal of Political Economy 24, 763777.
Das, S., Malimipalli, M. and Nayak, S. (2014) Did CDS trading improve the market for corporate bonds? Journal of Financial Economics 11, 495525.
Delatte, A.-L., Gex, M. and Lopez-Villavicencio, A. (2012) Has the CDS market influenced the borrowing cost of European countries during the sovereign crisis? Journal of International Money and Finance 31, 481497.
Gande, A. and Parsley, D. (2014) Sovereign Credit Ratings, Transparency and International Portfolio Flows. HKIMR Working Paper: No. 12/2014.
Gilson, S. C., John, K. and Lang, L. H. P. (1990) Troubled debt restructurings: An empirical study of private reorganization of firms in default. Journal of Financial Economics 27, 315353.
Hainmueller, J. (2012) Entropy balancing for causal effects: A multivariate reweighting method to produce balanced samples in observational studies. Political Analysis 20, 2546.
Hassan, M. K., Ngene, G. M. and Yu, J.-S. (2015) Credit default swaps and sovereign debt markets. Economic Systems 39, 240252.
Heckman, J. (1979) Sample selection bias as a specification error. Econometrica 47, 153161.
Imbens, G. W. (2004) Nonparametric estimation of average treatment effects under exogeneity: A review. Review of Economics and Statistics 86, 429.
Ismailescu, I. and Phillips, B. (2015) Credit default swaps and the market for sovereign debt. Journal of Banking and Finance 52, 4361.
Laeven, L. and Valencia, F. (2013) Systemic banking crises database. IMF Economic Review 61, 225270.
Li, K. and Prabhala, N. R. (2007) Self-selection models in corporate finance. In Handbook of Corporate Finance: Empirical Corporate Finance I, Chapter 2, pp. 3786. Amsterdam: Elsevier.
Lin, S. and Ye, H. (2007) Does inflation targeting really make a difference? Evaluating the treatment effect of inflation targeting in seven industrial countries. Journal of Monetary Economics 54, 25212533.
Massa, M. and Zhang, L. (2012) CDS and the Liquidity Provision in the Bond Market. INSEAD Working Paper: No. 2012/114/FIN.
Minea, A. and Tapsoba, R. (2014) Does inflation targeting improve fiscal discipline? Journal of International Money and Finance 40, 185203.
Neuenkirch, M. and Neumeier, F. (2016) The impact of US sanctions on poverty. Journal of Development Economics 121, 110119.
Parlour, C. and Winton, A. (2013) Laying off credit risk: Loan sales versus credit default swaps. Journal of Financial Economics 107, 2545.
Peristiani, S. and Savino, V. (2011) Are credit default swaps associated with higher corporate defaults? FRBNY Staff Report 494.
Qian, Z., Wang, W. and Ji, K. (2017) Sovereign credit risk, macroeconomic dynamics, and financial contagion: Evidence from Japan. Macroeconomic Dynamics 21, 20962120.
Roberts, M. R. and Whited, T. M. (2012) Endogeneity in empirical corporate finance. In: Handbook of the Economics of Finance 2, Chapter 7, pp. 493572. Amsterdam: Elsevier.
Saretto, A. and Tookes, H. E. (2013) Corporate leverage, debt maturity, and credit supply: The role of credit default swaps. Review of Financial Studies 26, 11901247.
Shim, I. and Zhu, H. (2014) The impact of CDS trading on the bond market: Evidence from Asia. Journal of Banking and Finance 40, 460475.
Staiger, D. and Stock, J. H. (1997) Instrumental variables regression with weak instruments. Econometrica 65, 557586.
Stein, J. (1987) Informational externalities and welfare-reducing speculation. Journal of Political Economy 95, 11231145.
Stulz, R. M. (2010) Credit default swaps and the credit crisis. Journal of Economic Perspectives 24, 7392.
Subrahmanyam, M., Tang, D. and Wang, S. (2014) Does the tail wag the dog? The effect of credit default swaps on credit risk. Review of Financial Studies 27, 29262960.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
×

Keywords

Type Description Title
WORD
Supplementary materials

Balima et al. supplementary material
Balima et al. supplementary material 1

 Word (430 KB)
430 KB

Metrics

Altmetric attention score

Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed