U.S. MONETARY POLICY AND SOVEREIGN CDS MARKETS

Abstract

This paper analyzes the effects of U.S. monetary policy on sovereign credit default swap (CDS) markets in a total of 66 countries including both advanced and emerging market economies at the monthly time horizon from 2001 to 2016. We employ a four-variable vector autoregression (VAR) model to estimate the monetary policy shock and examine the pass-through of U.S. monetary policy shocks to sovereign CDS markets. We find that the effect of monetary policy shocks on CDS markets is strong, especially during the European sovereign debt crisis and the period the U.S. monetary policy rate was near zero. Our analysis indicates that expansionary U.S. monetary policy leads to the widening of the sovereign credit spreads and the heightening of the CDS market volatility.