Series: Working Papers. 1723.
Author: Miguel Antón, Sergio Mayordomo and María Rodríguez-Moreno.
Topics: Financial risks | Quantitative methods | Government debt | Financial institutions, Banks | Credit.
Published in: Journal of Banking and Finance, Volume 90, May 2018, Pages 96-112
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Abstract
We show that sovereign CDS that have common dealers tend to be more correlated, especially when the dealers display similar quoting activity in those contracts over time. This commonality in dealers’ activity is a powerful driver of CDS comovements, over and above fundamental similarities between countries, including default, liquidity, and macro factors. We posit that the mechanism causing the excess correlation is the buying pressure faced by CDS dealers for credit enhancements and regulatory capital reliefs. An instrumental variable analysis confirms that our findings are indeed rooted in a causal relationship.