From Ecole Des Hautes Etudes Commerciales du Nord :
We perform a theoretical and empirical analysis of the relationship between the price of Eurozone
sovereign-linked credit default swaps (CDS) and the same sovereign bond markets during
the Eurozone debt crisis of 2009-2011. We first present a simple model which establishes the
no-arbitrage relationship between CDS and bond yield spreads. We then test this relationship
empirically and explain why the market may deviate from it. Reasons include the different
currencies of denomination of market-standard CDS and their reference obligations. We also
examine whether CDS spread cause changes in bond spreads, and vice-versa, in a Granger sense.
We find evidence for a Granger causal relationship with a one day lag from CDS to bonds for
Greece and Spain, the reverse relationship for France and Italy and a feedback relationship for
Ireland and Portugal.
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