Assessing geopolitical risk: Sovereign CDS insights from the Russo-Ukrainian War

Abstract

This study investigates how sovereign Credit Default Swaps’ (CDS) reactions reflect a country’s financial resilience to military conflicts, specifically analyzing the Russo-Ukrainian War. We find that sovereign CDS offers unique insights compare to equity markets. Sovereign CDS spreads had already started to increase at least two weeks before the outbreak of the war. Second, prior to the war, abnormal sovereign CDS spreads is correlated with financial vulnerability such as the Debt-to-GDP ratio, while after the outbreak of the war NATO membership and distance from Moscow become the significant predictor of abnormal sovereign CDS spreads indicating a shift in risk assessment dynamics towards geopolitical considerations. This divergence between equity market and sovereign CDS responses highlights their ability to capture different aspects of market sentiment and risk, underscoring the importance of sovereign CDS in evaluating the financial implications of geopolitical instability.