We develop a framework to analyse the credit default swap (CDS) market as a network of risk transfers among counterparties. From a theoretical perspective, we introduce the notion of flow-of-risk and provide sufficient conditions for a bow-tie network architecture to endogenously emerge as a result of intermediation. This architecture shows three distinct sets of counterparties: (i) Ultimate Risk Sellers (URS), (ii) Dealers (indirectly connected to each other), (iii) Ultimate Risk Buyers (URB). We show that the probability of widespread distress due to counterparty risk is higher in a bow-tie architecture than in more fragmented network structures. Empirically, we analyse a unique global dataset of bilateral CDS exposures on major sovereign and financial reference entities in 2011–2014. We find the presence of a bow-tie network architecture consistently across both reference entities and time, and that the flow-of-risk originates from a large number of URSs (e.g. hedge funds) and ends up in a few leading URBs, most of which are non-banks (in particular asset managers). Finally, the analysis of the CDS portfolio composition of the URBs shows a high level of concentration: in particular, the top URBs often show large exposures to potentially correlated reference entities

China’s climb to a trading powerhouse has changed its position in the world and therefore its relationships with other economies. As a result, its sovereign credit risk, which we measure by the pricing of its credit default swaps (CDS), now has the potential to greatly impact other sovereign CDS spreads. Employing a dynamic approach, we find that changes in China’s sovereign risk has strong contagion effects on its goods and service providers, while China is vulnerable to contagion effects from its major importers, suggesting sovereign risk spills over to other regions via the global supply chain. China’s success hurts some of the weaker countries in Europe by competing for their customers, while China faces strong competition itself from its export-focused neighbors. FDI and portfolio investment also affect the CDS relationships between China and other economies

In standard public finance theory a government's cost of borrowing depends on the common beliefs held by rational investors regarding default risk. We advance understanding of the effects of diverse beliefs and overconfidence among investors in their ability to assess the sovereign's creditworthiness. Theoretically, we find that demand for insurance against default is positively related to the absolute difference between the market price of sovereign risk and the risk forecasted by the economy's fundamentals. We find preliminary support for this prediction in a newly available dataset on sovereign credit default swaps (CDSs): after controlling for the size of the public debt, the absolute size of the gap between the actual and forecasted spreads is positively related to the value of outstanding CDSs

The credit default swap (CDS) market attracted much debate during the 2008 financial crisis. Opponents of CDS argue that CDS could lead to financial instability as it allows speculators to bet against companies and make the crisis worse. Proponents of CDS believe that CDS could increase market competition and benefit hedging activities. Moreover, an efficient CDS market can serve as a barometer to regulators and investors regarding the credit health of the underlying reference entity. We investigate information efficiency of the U.S. CDS market using evidence from earnings surprises. Our findings confirm that negative earnings surprises are well anticipated in the CDS market in the month prior to the announcement, with both economically and statistically stronger reactions for speculative-grade firms than for investment-grade firms. On the announcement day, for both positive and negative earnings surprises, the CDS spread for speculative-grade firms presents abnormal changes. Moreover, there is no post-earnings announcement drift in the CDS market, which is in direct contrast to the well-documented post-earnings drift in the stock market. Our evidence supports the efficiency of the CDS market

This paper studies how the Greek sovereign credit event in March 2012 impacted the credit default swap (CDS) market from market-wide and investor behaviour perspectives, using both network tools to a dataset of snapshots of the global bilateral CDS exposures and a panel analysis on CDS spreads. Regarding the CDS spreads, we find very little discernible direct impact of the Greek credit event on CDS spreads overall. This finding provides some further evidence that the Greek credit event was well anticipated by most market participants. However, we find several significant changes in the Greek CDS network structure following the credit event: the number of connections via exposures declined significantly, the directionality of the positions (net long vs net short) of the main groups of market participants reversed, while none of the non-banks returned to trade Greek CDSs until the last observation of dataset (October 2014). Regarding indirect effects to other CDS markets, we find evidence of temporary spill-over effects on CDS reference entities with credit risk associated with the risk of the Greek sovereign. In particular, the market and counterparty structures changed temporarily with all types of traders decreasing their exposures to the EU periphery sovereign reference entities and also changing their trading counterparties, while after some time, the structure of the market returned to a similar one observed before the credit event. Finally, we find some support for the bank-sovereign nexus, as there was a consistent retreat from the CDS exposures on banks in the EU periphery countries, contrary to banks residing in the other EU countries

We find that the magnitude of unique credit default swap (CDS) market information (constructed to be orthogonal to contemporaneous and lagged stock returns) declined after recent reforms that increased the level of post-trade regulatory and market transparency for CDSs. Around the same reforms, the ability of this CDS-unique information to predict future stock returns decreased. These results suggest the CDS market has become less of a “hidden” trading venue for informed investors since central clearing and trade reporting started

Outside of financial crises, investors have little incentive to produce private information on banks’ short-term liabilities held as information-insensitive safe assets. The same does not hold during crises. We compare the information effects of different policy interventions. We measure information production using credit default swap spreads during the Global Financial Crisis and the European debt crisis. We study abnormal information production around major events and find that capital injections reduced abnormal information production while early European stress tests increased it. High levels of information production predict bank balance sheet contraction and higher government expenditures to support financial institutions

We estimate a standard structural model of credit risk to draw insights about the premium demanded by investors for bearing default risk, using data on credit default swaps and market capitalization. We pin down the daily market value of assets for a set of non-financial firms and uncover cross-sectional heterogeneity in terms of the magnitude and time variation of the premium. By exploring the link between asset and default risk premia, we show that this heterogeneity closely depends on the relationship between the firm-specific market value of the assets and the business cycle

This paper studies the country-level reaction of bank credit default swap (“CDS”) spreads and stock prices to bailout announcements in the US and five European countries in October 2008. Bailouts announcements are associated with bank CDS spreads narrowing, both for domestic and foreign banks, pointing to an important role for cross-border exposures. Movements in bank stock prices show mixed reactions, both domestically and cross-border, with banks receiving favorable government support outperforming foreign rivals. By January 2010, bank CDS spreads had stabilized at higher levels reflecting greater default risk, while bank stock prices remained significantly below their pre-crisis levels

Using a large sample of firms with single-name credit default swap (CDS) contracts in 30 countries, we document the evidence that political uncertainty, proxied by national election dummy, is positively related to firm-level credit risk. Specifically, this positive relation is more pronounced for the firms that have no political connection or poor international diversification, and in the countries with higher political uncertainty and lower investor protections. Further, by using a difference-in-differences approach, we find evidence to support idiosyncratic volatility and debt rollover channels through which political uncertainty affects the credit risk of individual firm