The Relative Pricing of Sovereign Credit Risk after the Eurozone Crisis

Abstract

The paper analyses the relative pricing between sovereign CDS spreads and sovereign bond yields, for European countries, during and after the sovereign debt crisis of 2010-2012. In particular, we focus on the cross-sectional relationship between CDS spreads and bond yields across the European countries, and we investigate whether the differences across countries in terms of default risk, priced in the CDS spreads, are consistently priced in the cross-section of the bond yields. We show that an inconsistent cross-sectional relationship between CDS spreads and bond yields emerges during the crisis period for all the European countries, while after the announcement of the Outright Monetary Transaction (OMT) Programme, by the European Central Bank, the consistent cross-sectional relationship between default risk and bond yields is restored for the Eurozone countries only.