Factors affecting credit default swaps as indicators of sovereign risk: Asymmetric casuality method

Credit derivatives are derivative instruments that are used to hedge against credit risk. Credit default swaps are the most preferred contracts among credit derivatives. Credit default swaps, often referred to as CDS (Credit Default Swap) in this study, can be considered as an insurance contract against the default risk. CDS contracts provide protection for the buyer against default risk in return for certain premiums. The underlying assets of CDSs are debt obligations such as bonds and loans. These debt obligations may belong to companies, financial institutions or countries. The other function of these contracts issued to protect against default risk is to reflect default risk. CDS has become a frequent tool in recent years as an important indicator of sovereign default risk. In this study, we examine the causality relationship between the CDS's which are considered as an indicative of the country's risk and the financial variables that are thought to affect the country's CDS premiums. For this purpose; the casuality relationship between CDS premiums for 2005-2015 belonging to 17 countries, including Turkey, Japan, China, Brazil, Argentina, Mexico, Indonesia, Philippines, Russia, South Korea, Poland, Malaysia, Germany, Portugal, Italy, Spain and France, and US dollar currency, US 10-year government bond interest rate and VIX index is investigated. Two tests, symmetric and asymmetric, were applied to reveal this relationship in the study. First test is the Granger causality test and the second test is Hatemi-J (2012) asymmetric causality test. As a result of the study, it is seen that there is an asymmetric causality relationship between CDS premiums and selected financial variables. It is also observed that Hatemi-J asymmetric causality test is more effective than the Granger test in explaining the causality relationship between CDS premiums and selected financial variables. Keywords: Credit Default Swaps, Sovereign Risk, Credit Derivatives,Asymmetric Casuality Test, Granger Casuality Test