Sovereign credit default swaps and the macroeconomy

Abstract

The aim of this study is to determine whether the domestic economy as represented by the interest rate, the international economic status as represented by the exchange rate or both determine sovereign Credit Default Swap (CDS) spreads. Using a Vector Autoregressive (VAR) and Granger noncausality tests, the results suggest that it is the exchange rate that has the most important effect on sovereign CDS spreads, with domestic interest rates having only a limited effect. There is also some evidence of causality running from the CDS spread to the exchange rate.

Keywords:

• CDS spread
• exchange rate
• Granger noncausality

JEL Classification:

• G15
• G32

Notes

¹Although other factors such as credit ratings could also be included, for the two countries tested their rating remained the same at AAA throughout, so the factors were not included.