Are Credit Default Swaps Spreads High in Emerging Markets-An Alternative Methodology for Proxying Recovery Value
ISBN: 9781451920437
Platform/Publisher: Ebook Central / International Monetary Fund
Digital rights: Users: Unlimited; Printing: Limited; Download: 7 Days at a Time
Subjects: Economics; Business/ Management;

In times of distress when a country loses access to markets, there is evidence that credit default swap (CDS) spreads are a leading indicator for sovereign risk than the EMBI+ sub-index for the country. However, it is not easy to discern the variables that determine the level of CDS spreads in Emerging Markets (EM); traders only quote the CDS spreads and not the inputs that are required to calculate such spreads. This note provides some evidence from Argentina and Brazil that reveals inconsistency between theory and practice in pricing CDS spreads in EM. This note suggests an alternate methodology that links CTD (cheapest-to-deliver) bonds to recovery values assumed in CDS contracts. Furthermore, special features that pertain to CDS contracts (repo specialness, short squeezes by central banks) may also magnify the financial distress of a sovereign.


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