The purpose of this study is to explore the interactions between global financial indicators and sovereign CDS spreads. The second objective of this thesis is to find variables which can be used for predicting the prospective values of CDS spreads in a particular group of countries. The previous researches usually focus on the European countries and some particular regions in Asia and South America. One of the most comprehensive research belongs to Longstaff, Pan, and Pedersen’s (2011) paper which analyses 26 countries. In this thesis, the countries which are categorised as emerging market from different geographical regions will be examined.
In the beginning of the empirical part, I look into any contemporaneous relationship between financial indicators and sovereign CDS spreads. For this part, regression analysis is conducted. I find a powerful relationship between stocks index returns and CDS spreads. They are also economically significant, especially MSCI EM index. In addition to this, the VIX index, which is a proxy for global risk appetite, has low economic significance. Oil prices are found not statistically significant. The second part of the empirical work is related to predictivity relation. In this part, the Granger causality test is conducted. Before the Granger test, VAR analysis is conducted. In VAR models, the economic significance of lagged values of stock returns are lower than the economic significance of regression results which contain no lagged variable. Secondly, the explanatory power of lagged values is lower than the explanatory power of first regression results. According to Granger test results, stock index returns and bond spread affect sovereign CDS spreads and conversely sovereign CDS spreads affect stock index returns and bond spread. These variables have strong predictivity power. VIX index has very limited predictivity power for the Emerging market countries.
This study is organised as follows; second part of the study will be literature review regarding CDS spreads, the third part will be regarding development of hypothesis of the study, the fourth part will be empirical analysis and the fifth part will be conclusion.