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CDS Spreads in European Periphery: Some Technical Issues to Consider
Author:
Mr. Manmohan Singh
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and
Mr. Mohsan Bilal
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Series:
IMF Working Papers
Volume/Issue:
Volume 2012: Issue 077
Language:
English
Publication Date:
01 Mar 2012
DOI:
https://doi.org/10.5089/9781475502299.001
ISBN:
9781475502299
ISSN:
1018-5941
Pages:
18
Keywords:
WP; CDS; derivative; CDS spread; bank; CDS spreads; peripheral Europe; stochastic recovery rate; probability of default; collateral use in OTC derivatives; cheapest-to-deliver bonds; price of risk; CDS contract; CDS data; CDS recovery; CDS signal; OTC derivative; CDS settlement; Credit default swap; Derivative markets; Bonds; Over-the-counter markets; Collateral; Europe
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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This paper looks at some technical issues when using CDS data, and if these are incorporated, the analysis or regression results are likely to benefit. The paper endorses the use of stochastic recovery in CDS models when estimating probability of default (PD) and suggests that stochastic recovery may be a better harbinger of distress signals than fixed recovery. Similarly, PDs derived from CDS data are risk-neutral and may need to be adjusted when extrapolating to real world balance sheet and empirical data (e.g. estimating banks losses, etc). Another technical issue pertains to regressions trying to explain CDS spreads of sovereigns in peripheral Europe - the model specification should be cognizant of the under-collateralization aspects in the overall OTC derivatives market. One of the biggest drivers of CDS spreads in the region has been the CVA teams of the large banks that hedge their exposure stemming from derivative receivables due to non-posting of collateral by many sovereigns (and related entities).
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund
Volume 2012: Issue 077