[Determinants of Sovereign borrowing default swap spread for PIIGS]

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Acknowledgement

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DECLARATION

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ABSTRACT

This study examines effects of changes in macroeconomic variables in CDS sovereign countries within bloc PIIGS. We run regressions for individual countries and inclusion of Germany as the benchmark. In addition to studying whole period (2004Q1-2009Q3), we divided into two sub-periods, first is financial stability and second is characterized by financial turmoil. THE Ramsey RESET test shows that our first model is correctly specified in second period. We find greatest number of significant variables in this model. For first time we met our regressions to be negligible.

In general we find unemployment rates to be most important determinant of differential frequency of CDS. Our study shows that in many cases, increasing public debt, independently and in relation to Germany, helps to widen CDS spreads. Moreover, we find mixed results for growth rate of GDP, while inflation is found to be least significant variable in our study.

Table of Contents

ABSTRACT1

CHAPTER I: INTRODUCTION3

1. INTRODUCTION3

1.1 BACKGROUND3

1.2 PROBLEM DISCUSSION6

1.3 Purpose8

1.4 Provision8

2. THEORY9

2.1 CREDIT RISK9

2.2 CREDIT SPREADS11

2.3 Credit Default Swaps13

2.4 PRICING CREDIT DEFAULT SWAPS15

CHAPTER III: METHODOLOGY19

3. METHODOLOGY AND EMPIRICAL PROCEDURE19

3.1 Data20

3.1.1 Country selection22

3.1.2 SELECTION VARIABLES22

3.2 MODELS24

3.3 DIAGNOSTIC TESTS26

CHAPTER IV: RESULTS28

4. RESULTS AND ANALYSIS28

CHAPTER V: CONCLUSION37

5. CONCLUSION37

REFERENCES38

APPENDIX42

Determinants of Sovereign borrowing default swap spread for PIIGS

Chapter I: Introduction

1. INTRODUCTION introductory chapter presents background of this work pursued by debate issue paper outlining purpose. chapter ends with provision of short paper transport section.

1.1 BACKGROUND

First, structures of Credit Default Swap (CDS) was created in mid 90's. Since its inception, this credit derivatives in particular has revolutionized market and has grown at an extremely rapid pace. CDS is credit derivative that is inherited and its value is derived from changes in underlying asset, or more specifically credit risk inherent in corporate and sovereign securities. Main features of credit derivatives that allows isolation of credit risk and allows replication, transfer and hedging of credit. According to Duffie (1999) at least three types of investors may be identified to be attracted to these activities: those looking for diversification, while identification of credit derivatives as the new asset class, those who seek to manage credit risk and looking for arbitration.

CSD was initially created solely for banks to manage credit risk. By allowing sale or credit risk mitigation, banks do not have to deny credit to customers to meet regulatory demands for maintenance of capital adequacy above certain threshold (Basel II, BIS 2004). Credit derivatives market in general and CDS in particular, grew from year to year and interestingly enough market had become increasingly dominated by players from gambling and ...