Title: Dynamic interaction between sovereign credit rating events and credit default swaps
Authors: Richard Luger - Laval University (Canada) [presenting]
Abstract: An empirical framework is proposed for modelling and assessing the dynamic interaction between credit rating events (changes in the rating or outlook) and CDS spreads, with a particular focus on the sovereign debt market. The approach combines: (i) a GARCH model for CDS spread changes; (ii) a dynamic logit model for credit rating events; and (iii) a dynamic copula model for the non-linear dependence structure between CDS spreads and credit rating events. The end result is a complete characterization of the dynamic dependencies, spillovers, and feedback effects between sovereign credit rating events and CDS spreads. We apply the new methodology to five Euro area countries (Greece, Ireland, Italy, Portugal, and Spain) after the collapse of Lehman Brothers and find evidence of asymmetric propagation effects of credit rating announcements (by Standard \& Poor's, Moody's, and Fitch) for one country on the sovereign CDS spreads and credit ratings of other countries.