“The Relative Pricing of Sovereign Credit Risk After the Eurozone Crisis”

by Raffaele Corvino, Francesco Ruggiero; CeRP WP n. 195/19

The paper analyses the relative pricing between sovereign credit default swap (CDS) spreads and sovereign bond yields for European countries during and after the sovereign debt crisis of 2010-2012. We investigate whether riskier countries compensate their debtholders properly by paying out suffciently higher bond yields compared to those of safer countries. We test whether the differences across countries in terms of the default risk priced in the CDS spreads are consistently priced in the cross section of the bond yields, and we show that an inconsistent cross-sectional relationship between CDS spreads and bond yields emerges during the crisis period for all European countries. However, after the announcement of the Outright Monetary Transaction (OMT) program by the European Central Bank, the consistent cross-sectional relationship between default risk and bond yields is restored for the Eurozone countries only.

Published: September 2019; revised version published in the Journal of International Money and Finance, 2020.