Characteristics and development of corporate and sovereign CDS

Abstract

Purpose – This paper aims to provide an overview of the market for corporate and sovereign credit default swaps (CDS), with particular focus on Europe. It studies whether the subprime crisis of 2007/2008 and, particularly, the European debt crisis 2009/2010 led to a differential development on corporate and sovereign CDS markets and investigates the primary use (speculative risk-trading or risk-hedging) of the two markets in recent years. Design/methodology/approach – The authors use aggregate market data on the size of the respective markets and on the structure of market participants and their changes over time to assess the main research question. They enhance existing data from public sources such as the Bank for International Settlements and Depository Trust and Clearing Corporation with their own statistics on European sovereign CDS and combine their conclusions with observations regarding standardisation efforts and regulatory changes in the CDS market. Findings – The authors show that after the subprime crisis 2007/2008 and the European debt crisis 2009/2010, the corporate and sovereign CDS markets developed quite differently. They provide evidence that since mid-2010, market participants started to use the sovereign CDS market more strongly for speculative purposes than for risk-hedging. This shows both in the shift of risk-quality of sovereign CDS contracts and in the changing structure of market participants. The ongoing standardisation and regulation in the CDS market – leading to further increases in transparency and reductions in transaction costs – may be expected to trigger a similar change also for corporate CDS. Originality/value – Based on a broad variety of market infrastructure data, the authors show a diverging development of corporate and sovereign CDS markets in Europe in recent years. Particularly the sovereign CDS market appears to have shifted from a risk-hedging instrument to being used more strongly for speculative risk-trading. The authors combine their findings with recent regulatory action and market standardisation schemes and draw conclusions for the future development of CDS markets.