Determinants of Sovereign Credit Default Swap spreads for PIIGS - A macroeconomic approach

Abstract: This study examines the effects of changes in macroeconomic variables on sovereign CDS spreads for the countries within the PIIGS block. We run regressions for the countries individually and with the inclusion of Germany as a benchmark. In addition to study the whole time period (2004Q1-2009Q3), we divided it into two sub-periods, the first being financially stable and the second being characterized by financial turmoil. A Ramsey RESET test shows that our first model is correctly specified during the second sub-period. We find the highest number of significant variables in this particular model. For the first sub-period we find our regressions to be insignificant. Overall we find unemployment rates to be the most frequently significant determinant of the CDS spread. Our study shows that, in many cases, increasing government debt, independently as well as relative to Germany, contributes to wider CDS spreads. Furthermore we find varying results for GDP growth rate, while inflation is found to be the least significant variable in our study.