SCDS Research Paper

1.INTRODUCTION

The European credit crisis has stimulated an intense debate about the usefulness of the Sovereign Credit Default Swaps (SCDS) as an essential tool in credit risk management, and their use as market credit risk’s indicator. According to Coudert and Gex (2010), the high liquidity feature of SCDS and their lead in price discovery, which make it more decisive compared to sovereign bond derivatives, emphasize its importance of managing sovereign risk. Thus, pricing the SCDS spread is a great step to gain a deeper understanding of how to manage them.

This research builds on two strands of SCDS literature to price the SCDS spreads. First, I consider the empirical studies of macroeconomic fundamentals, which is a part of local factors

I investigate institutions’ effects through some country’s specific factors, such as legal origin, corruption perception index (CPI), International Financial Reporting Standards (IFRS), Transparency, Financial structure and Societal Trust. I conduct this experiment based on La Porta et al. (2008) revelation to evaluate these institutional factors on the SCDS spreads, but not to compare the explanatory power of global and local factors on SDCS spreads. The results provide the following evidence: in average common law origin and less corrupted countries have their CDSC spread lower by at least 26.2 % compared to civil law origin and highly corrupted countries; SCDS spreads is lower for countries that present their financial statement with more transparency; financial structure of OECD country members and highly trusted countries negatively react with the SCDS spreads. I further check the robustness of those findings by using 10-year SCDS spreads, and the main results still remain and fully significant. Thus, I contribute to the SCDS spread literature according to the above finding, especially with the impact of legal system origin on the SCDS