October 13, 2011 No.

751

What are the determinants of sovereign CDS?

Against the backdrop of sovereign stress, we examine the role of macroeconomic and financial variables in the rise in sovereign CDS for a sample of 37 countries between January 2004 and August 2011. To do so, we estimate a random and fixed-effect panel to explain sovereign CDS. We also divide our sample into 18 developed countries and 19 emerging markets to reveal their specific characteristics. Our results show that: the fundamental variables used present the expected signs and effects, namely a deterioration in public finances, a reduction in GDP growth per capita, rising inflation, a loss of competitiveness (except in emerging countries) and a deterioration in governance, which all lead to a rise in sovereign CDS; the budget balance has the highest explanatory power of all fundamental variables both in emerging and developed countries; the global variable also plays a decisive role, with a 10% hike in risk aversion producing a 16% rise in the CDS level across the sample, which corresponds to 24bps; the impact of risk aversion and inflation is much greater on emerging countries CDS than on those of developed countries. The CDS variation over the period of study can be explained equally well by the fundamentals (52%) and the market variables (48%). The importance of the primary
ECONOMIC RESEARCH Authors: Christian OTT Juan Carlos RODADO

budgets role as a fundamental variable shows that current sovereign pressure is largely due to the unprecedented deterioration in developed countries public finances.

As sovereign CDS surge

The intensification of the sovereign crisis in Europe has brought renewed interest in acquiring a better understanding of the reasons behind country risk, a concern that is usually confined to emerging markets, in view of their frequent crises, but now also applies to the markets of industrialized countries. Against the backdrop of sovereign stress, we examine which macroeconomic and financial factors explain the rise in sovereign risk in a sample of 37 emerging and developed countries (Charts 1a-1b).

800

Chart 1a 5-year sovereign CDS (bp, avge.)

800

400 350
600

Chart 1b 5-year CDS variation betw een Jan. & Aug. (bp) 375
*Excl. Spain **Excl. Italy

600

Develo ped Emerging

300 250

400

400

200 150

200

200

100 50

48
Sources: Datast ream, NATIXIS

26

22 EM Asia

21 G7**

0 04

Sources: Datast ream, NATIXIS

0
0 09 10 11

Peripheral

LATAM

EM Europe

05

06

07

08

what is the role of macroeconomic and financial variables?

Sovereign risk is usually assimilated to the spread between the yield from a countrys sovereign bonds and the yield from US bonds of equal maturity. This spread widens as the country in question becomes more likely to default. Recent studies use CDS as a proxy for sovereign risk. There is a close relationship with this variable because the cost to insure a bond portfolio is linked to its default probability even if holding the underlying asset is not necessary. While most empirical studies have focused on emerging markets sovereign spreads in an effort to explain sovereign risk, we broaden this analysis to CDS. This allows us to extend our sample to developed countries. Although the CDS market is narrow and relatively new, in the last five years it has doubled in size to USD 2.5 trillion, i.e. 6% of the stock of sovereign debt1. The gross positions on some CDS may reach considerable sums both in developed countries and emerging markets (Chart 2).

300 250 200 150 100 50 0 Romania

Chart 2 Sovereign CDS gross positions (USD bn.) 183 121 125 147

301

105 108 67 68 69 76 52 56 57 57 59 60 42 51 40 40 Sources: DTCC, NATIXIS 24 29 31 33 10 11 18 18 20 20 Colombia CZ Rep. Germany Portugal Belgium Greece

France

Malaysia

Slovakia

Indonesia

Thailand

Mexico

Turkey

Peru

Ireland

Japan

UK

Russia

Poland

China

United States

Netherlands

Philippines

Hungary

Bulgaria

Austria

Argentina

For an overview of the CDS market, see Flash No. 2011-623: Cash vs. CDS sovereign markets (I)
Flash 2011 - 751 - 2

Venezuela

Brazil

Italy

Domestic vs. global variables

To explain sovereign risk, we use the Edwards model (1986 2 ) to determine sovereign spreads that we apply to CDS. This reveals the co-existence of two types of explanatory variables:

sovereignrisk (it ) c X (t ) Z (it ) (it )

The sovereign risk of a given country (i) changes over time (t) as a function of external (X) and domestic (Z) vectors. We remind readers that we use 5-year CDS sovereign risk as a proxy. These CDS are useful since they are cash instruments for hedging against the risk of default and data is widely available across the sample. Our database includes 37 emerging and developed countries with a monthly periodicity extending from January 2004 to August 2011. To assess sovereign risk, we have selected a number of representative variables from the fundamental and global variables (tableau 1). These can be organized into five types of risk: Macroeconomic: determined using real, GDP growth per capita and inflation rates. A countrys increased wealth is likely to improve its payment capacity and thus reduce sovereign risk. Inflation on the other hand tends to exacerbate sovereign risk. External fragility: a highly volatile real effective exchange rate (REER) may indicate pressure on the currency or pressure on pricecompetitiveness. Both may compromise a countrys capacity to generate revenues to meet its external commitments. The current-account balance, external debt and foreign exchange reserves have also often been used to assess the external vulnerability of emerging markets. Fiscal: the budget deficit and public debt play a key role in the sustainability of public finances. Any improvement in a countrys fiscal position reduces its default probability. Governance: this is a qualitative yardstick, analyzed using a composite governance indicator from the World Bank. The concept encompasses a much broader, in-depth approach than just political risk, examining six dimensions that affect the quality of a countrys institutions. As governance deteriorates (graded from 1 to 6 for the poorest governance3) sovereign risk rises. Global: this involves a series of variables that are likely to affect all markets at the same time. A rise in risk aversion or fall in global liquidity would lead to an upsurge sovereign risk. Fluctuating oil prices might also influence an importing or exporting countrys ability to pay.

Edwards S. (1984), LDCs Foreign Borrowing and Default Risk: An Empirical Investigation 1976-1980, American Economic Review 74 (4), Sept, 726-734. 3 / Political Stability & Absence of Violence 2/ Regulatory Quality 3/ Government Effectiveness 4/ Rule of Law 5/ Control of Corruption 6/ Voice and Accountability.
Flash 2011 - 751 - 3

Table 1. De s cr iption of var iable s V ariable CDS GDP per capita GDP grow th per capita Inf lation Governance Budget balance Public debt Current-account balance External debt Foreign exchange reserves Real ef f ective exch. rate Real ef f ective exch. rate volatility Brent Liquidity V ix Risk perception index
So urc e: N A T IXIS

De s cription 5-year sovereign CDS Nominal GDP per capita Nominal GDP per capita, year-onyear Consumer prices, year-on-year Composite governance index (1=good, 6=poor) Budget balance as % of GDP Public debt as % of GDP Curr. acc. balance as % of GDP External debt as % of GDP Foreign exchange reserves Real ef f ective exchange rate 3 month-on-month standard deviation of REER Brent price Global monetary base as % of w orld GDP S&P 500 volatility index Risk perception index

Unit Base points Dollars Percentage Percentage Index Percentage Percentage Percentage Percentage Dollars Index Index Dollars Percentage Index Base points

Fr e que ncy Inte r polation Monthly A nnual A nnual A nnual A nnual A nnual A nnual A nnual A nnual A nnual Monthly Monthly Monthly Monthly Monthly Monthly Non Y es Y es Y es Y es Y es Y es Y es Y es Y es No No No No No No

Sour ce Bloomberg WEO, FMI WEO, FMI WEO, FMI World Bank WEO, FMI WEO, FMI WEO, FMI WEO, FMI EIU, Bloomberg BRI BRI Datastream Datastream CBOE NA TIXIS

Data is essentially taken from the International Monetary Funds World Economic Outlook, as well as from the World Bank, the BIS, Datastream and Bloomberg. It should be noted that where monthly series were not available, we converted them using linear interpolation, a method often adopted in high-frequency studies on sovereign spreads (Goldman Sachs 20004, Bellas et al 20105). Tables 2 & 3 show some statistics on the main data and their correlation with the sovereign CDS in each country. GDP per capita, inflation, governance, public debt, external debt, exchange rate volatility, risk aversion and world monetary base are positively correlated with CDS, while GDP growth per capita and the budget balance are negatively correlated with CDS. The current-account balances weak correlation reflects a non-linear relationship with CDS.

Goldman Sachs (2000), A new framework for assessing fair value in EMs hard currency debt, Global Economics Paper, No. 45. Bellas D., Papaioannou M. and I. Petrova (2010), Determinants of Emerging Market Sovereign Bond Spreads: Fundamentals vs. Financial Stress, IMF Working Paper 10/281.
5

Flash 2011 - 751 - 4

5-ye ar CDS United States A ustria China France Germany Japan Italy Belgium Portugal Netherlands Greece Ireland CZ Rep. Hungary Poland A rgentina V enezuela Brazil Chile Colombia Peru Mexico Malaysia Romania Bulgaria Turkey Estonia Indonesia Lativa Lithuania Slovakia Russia Slovenia Thailand Philippines V ietnam A verage
So urc e: N A T IXIS

Table 2. De s cr iption of var iable s (ave r age , Januar y 2004-Augus t 2011) GDP GDP Cur r. REER gr ow th Infl- Gove r - Budge t Public Exte rnal For . e xch. pe r acc. REER volpe r ation nance bal. de bt de bt Re s e r ve s capita balance atility capita 44696 41918 2746 39147 39002 38097 37229 33338 40165 20336 44414 25640 50984 15595 12251 10007 6521 7932 7007 8948 4418 3765 8849 6518 6433 5103 8373 13213 1939 9906 9899 12710 7908 21540 3679 1521 854 17638 0,67 4,89 15,91 4,17 1,26 4,19 4,27 3,10 4,37 4,01 4,98 4,93 2,60 9,64 3,17 9,49 7,46 -6,91 13,34 10,89 9,58 9,02 0,80 7,48 10,04 8,78 4,40 8,66 8,05 8,12 9,44 13,11 11,43 5,73 8,80 4,97 3,50 6,44 2,45 1,88 2,89 1,85 2,43 1,68 -0,10 2,13 2,17 1,99 1,53 3,28 1,56 2,53 5,23 2,67 8,79 22,99 5,88 3,38 5,00 2,74 4,39 2,47 7,84 6,10 9,53 4,30 7,83 6,42 3,92 3,48 10,85 3,07 3,10 5,43 9,87 4,69 1,78 1,31 4,17 1,72 1,60 1,49 1,76 2,49 1,63 1,83 1,30 2,50 1,37 2,09 2,11 2,44 3,98 5,31 3,34 1,78 3,97 3,95 3,56 2,98 3,16 3,06 3,47 1,91 4,32 2,45 2,36 2,28 4,59 1,96 3,62 4,08 4,22 2,76 -6,08 -2,34 -1,32 -4,35 -5,33 -2,22 -6,15 -3,63 -2,08 -4,98 -1,74 -8,35 -6,40 -3,50 -5,60 -4,86 -2,21 -1,92 -2,99 2,94 -1,31 0,28 -2,17 -3,86 -3,79 1,09 -2,73 0,77 -0,54 -3,57 -3,31 -3,99 3,07 -2,03 -0,03 -2,82 -3,49 -2,74 70,76 64,51 17,82 69,88 52,46 69,40 196,31 108,84 92,22 67,38 54,41 112,99 45,81 32,02 68,66 48,08 76,88 34,31 68,36 7,29 36,92 29,56 41,41 47,04 22,85 24,12 47,31 5,21 39,29 19,47 22,91 35,20 12,84 28,81 43,83 55,23 44,71 51,76 -4,65 3,01 7,04 -1,00 -2,27 5,62 3,60 -2,27 1,38 -10,13 6,69 -10,38 -2,91 -2,57 -5,22 -3,23 2,16 10,80 -0,13 1,81 -2,02 -0,10 -0,79 14,75 -8,43 -13,40 -4,92 -7,82 1,48 -9,70 -6,59 -6,04 7,40 -2,84 2,69 3,46 -5,22 -1,10 19,64 2,88 -30,08 -3,27 17,66 -26,24 -58,50 8,80 -21,24 85,53 -56,88 81,15 34,67 19,07 70,55 29,74 43,53 8,94 10,39 25,91 14,16 7,76 10,48 -13,89 29,10 34,85 27,25 87,56 23,19 103,58 47,22 22,15 0,13 28,15 -15,10 25,52 12,61 19,11 80,20 8,60 1586,31 41,55 38,72 50,00 928,86 34,10 11,44 2,99 12,84 1,07 1,58 34,60 28,71 57,91 36,45 22,72 154,27 21,03 19,94 24,81 87,86 85,65 30,68 13,02 62,28 2,72 54,11 4,53 5,58 11,17 324,58 3,70 94,55 29,52 14,63 108,74 107,56 1,27 94,70 98,07 109,59 97,39 91,26 96,05 87,85 97,62 100,26 98,83 96,99 102,74 102,73 119,38 109,77 117,14 91,78 113,26 146,80 102,95 131,95 103,09 95,76 103,69 125,43 111,43 110,15 107,47 104,63 111,90 103,83 121,06 131,51 100,21 109,67 125,11 1,22 0,45 1,15 0,58 1,25 0,68 1,76 0,58 0,58 0,32 0,67 0,45 0,91 1,40 2,11 2,25 1,81 3,22 2,99 2,06 2,08 0,96 1,70 0,83 1,43 0,78 2,79 0,46 1,98 0,87 0,67 0,96 1,18 0,36 0,91 1,35

21,55 36,39 55,97 26,43 17,97 30,29 66,39 43,30 115,66 21,42 246,60 135,38 50,50 146,72 76,83 808,69 743,96 222,17 61,58 214,96 186,27 119,06 71,20 180,99 155,06 245,21 108,65 265,17 214,41 157,19 47,03 172,78 39,90 84,54 257,14 218,79 154,06

United Kingdom 34,02

Flash 2011 - 751 - 5

Table 3. Corre lation w ith 5-ye ar CDS in e ach country (January 2004-Augus t 2011) GDP For. REER Curr. GDP grow th Infl- Gove r- Budge t Public Exte rnal e xch. REER vol- Bre nt acc. pe r de bt pe r ation nance balance de bt re s . atility balance capita capita United States Austria China France Germany Japan Italy Belgium Portugal Netherlands Greece Ireland CZ Rep. Hungary Poland Argentina Venezuela Brazil Chile Colombia Peru Mexico Malaysia Romania Bulgaria Turkey Estonia Indonesia Latvia Lithuania Slovakia Russia Slovenia Thailand Philippines Vietnam Average
So urce: NA TIXIS

World m one tary bas e 0,87 0,86 0,69 0,88 0,89 0,90 0,94 0,91 0,84 0,73 0,83 0,74 0,80 0,79 0,89 0,84 0,57 0,76 -0,40 0,64 -0,32 -0,20 0,52 0,63 0,76 0,78 -0,20 0,62 -0,09 0,80 0,82 0,82 0,42 0,83 0,71 -0,41 0,62 0,60

VIX 0,68 0,77 0,90 0,45 0,73 0,61 0,51 0,50 0,39 0,12 0,77 0,13 0,25 0,84 0,78 0,81 0,92 0,88 0,03 0,91 0,20 0,30 0,87 0,91 0,88 0,88 0,40 0,90 0,52 0,87 0,86 0,80 0,86 0,69 0,90 0,12 0,73 0,64

0,62 0,70 0,60 0,57 0,68 0,92 0,53 0,57 0,38 0,67 0,34 -0,21 0,73 0,71 0,74 0,45 0,69 -0,61 0,41 -0,56 -0,40 0,26 0,63 0,64 0,73 -0,31 0,64 -0,29 0,74 0,75 0,77 0,35 0,63 0,66 -0,61 0,56 0,39

-0,65 -0,54 0,14 -0,61 -0,77 -0,50 0,57 -0,59 -0,58 -0,50 -0,47 -0,66 -0,53 -0,44 -0,54 -0,41 -0,06 -0,44 -0,36 -0,65 -0,26 -0,25 -0,42 -0,08 -0,56 -0,43 0,12 -0,58 -0,27 -0,68 -0,62 -0,39 -0,26 -0,52 -0,39 -0,44 -0,52 -0,41

-0,46 -0,03 0,36 -0,21 0,66 -0,29 -0,38 -0,35 0,09 -0,33 -0,12 0,27 -0,69 0,40 -0,05 0,70 -0,22 0,79 0,85 0,58 0,70 0,52 0,71 0,43 -0,22 0,11 0,60 0,49 -0,04 0,23 0,62 -0,42 0,50 -0,12 0,05 0,39 0,70 0,18

0,37 -0,02 -0,73 0,40 0,72 0,06 0,58 0,52 0,13 0,38 -0,03 0,80 0,73 -0,70 0,80 -0,70 0,31 0,69 -0,22 0,46 0,72 -0,30 0,35 0,48 -0,54 0,00 0,36 -0,57 0,39 0,73 0,38 -0,26 0,13 0,07 0,62 -0,50 0,20 0,18

-0,78 -0,17 -0,12 -0,79 -0,78 0,02 -0,75 -0,45 -0,69 -0,50 -0,45 -0,35 -0,84 -0,29 0,77 -0,41 0,21 -0,58 -0,35 -0,32 0,24 -0,27 -0,22 -0,33 -0,72 -0,39 -0,48 -0,78 -0,06 -0,82 -0,66 -0,48 -0,23 -0,59 -0,52 -0,37 -0,33 -0,40

0,80 0,49 -0,23 0,89 0,75 0,75 0,87 0,85 0,50 0,86 0,75 0,89 0,92 0,46 0,83 0,55 -0,38 -0,22 0,89 -0,17 0,53 -0,25 0,57 0,17 0,40 -0,55 0,39 0,17 0,38 0,47 0,30 0,00 -0,06 0,52 -0,55 0,73 0,33 0,39

0,77 0,57 0,12 -0,77 0,49 -0,04 -0,70 -0,71 -0,43 0,05 -0,60 0,00 0,39 0,55 0,67 -0,29 -0,38 -0,55 0,39 -0,70 0,56 -0,45 -0,76 0,35 0,26 0,03 0,36 0,27 -0,21 0,50 0,30 0,60 -0,34 -0,07 0,31 -0,87 -0,57 -0,02

0,48 -0,73 -0,55 0,89 -0,25 -0,80 -0,33 0,88 0,04 -0,21 -0,58 -0,26 0,71 0,48 0,66 0,64 -0,38 -0,17 0,80 0,11 0,67 0,48 -0,02 0,04 0,65 0,78 0,47 0,58 0,39 0,64 0,68 0,68 0,04 0,30 -0,62 0,68 -0,04 0,21

0,71 0,37 0,57 0,77 0,35 0,72 0,80 0,88 0,79 0,11 0,64 0,03 0,13 0,67 0,83 0,65 0,42 0,06 -0,53 0,46 -0,49 -0,37 0,26 0,41 0,54 0,66 -0,44 0,67 -0,35 0,59 0,51 -0,42 0,18 -0,65 0,59 -0,59 0,30 0,29

-0,50 -0,32 0,81 -0,74 -0,88 -0,53 0,40 -0,49 0,10 -0,61 -0,35 0,55 -0,27 0,56 0,15 -0,07 -0,12 0,73 -0,80 -0,09 -0,66 0,12 -0,80 0,21 -0,10 0,76 -0,53 0,72 -0,61 0,87 0,90 0,77 0,05 0,53 0,43 -0,74 -0,01

0,49 0,21 0,33 0,33 0,22 0,35 0,44 0,36 0,29 0,49 0,22 0,08 0,40 0,70 0,36 0,54 0,47 0,33 0,34 0,21 -0,10 0,04 0,36 0,22 -0,28 0,08 0,26 0,29 -0,06 0,26 0,44 0,11 0,30 0,22 0,07 -0,16 0,26

0,27 0,12 0,12 0,40 0,14 0,29 0,38 0,40 0,43 0,53 0,13 0,51 0,47 0,12 0,28 0,17 -0,08 0,04 -0,67 0,03 -0,66 -0,59 -0,13 0,15 0,10 0,13 -0,41 0,04 -0,48 0,12 0,13 0,20 -0,22 0,13 0,26 -0,61 0,16 0,06

United Kingdom -0,11

We estimate a panel for the various countries in our sample. The model is written as follows:

log cdsit i X it it , i 1,.....N ; t 1,.....T

Xit denotes the explanatory variables while denotes the (common) coefficient estimates. In order to control for unobserved heterogeneity we use random and fixed-effect models depending on which assumption holds, suggested by individual Hausman tests. However, we still have to assume that the impact of each explanatory variable (the coefficients) is the same for all countries.

Flash 2011 - 751 - 6

We thus divide our sample into 18 developed countries and 19 emerging markets. This division allows us to show the specific characteristics of each of the two groups. The risk of spurious regression is also reduced since the panel uses the average across countries variables (Smith 20016). We were also cautious regarding multicollinearity and endogeneity during the selection process of variables for the estimated equations. Table 4 sets out our estimates for each of the three country groups (total, developed and emerging). After testing all of the variables and possible configurations, we selected a specification based on five fundamental variables (budget balance, GDP per capita, inflation, governance, real effective exchange rate) as well as risk aversion.
Table 4. Pane l e s tim ate s (de pe nde nt var iable log of CDS) V ariable Budge t balance (% of GDP) GDP pe r capita (r e al, YoY %) Inflation (YoY %) Gove rnance (pts ) REER (log) V IX (log) Cons tant Number of countries Number of periods Number of observations Hausman test* R2 adjusted Levin, Lin & Chu test* Im, Pesaran & Shin test* A DF-Fisher test* All countr ie s -13,69
(-0.54)

De ve lope d countrie s -14,30

(0.70)

Em e rging countr ie s -6,00

(0.67)

-2,09
(0.15)

-3,82
(0.24)

-1,11
(0.15)

3,98
(0.67)

7,41
(1.24)

5,22
(0.58)

0,9
(0.12)

2,2
(0.24)

0,5
(0.08)

-1,02
(0.15)

1,84
(0.30)

-1,49
(0.13)

1,56
(0.03)

1,89
(0.05)

1,14
(0.03)

-3,37
(0.77)

-20,28
(1.52)

1,76
(0.66)

36 92 3274 Fixed ef f ects 0,81 Y es No No

18 92 1638 Fixed ef f ects 0,80 Y es No No

18 91 1636 Random ef f ects 0,57 Y es No No

So urc e: N atixis , Standard dev iatio n in parenthes es * Signfic ant at 5%, (Yes = unit ro o t, N o = no unit ro o t)

Overall, our R2 appears satisfactory (less so for emerging countries) while the unitroot test was rejected most of the time by our three conducted tests (Levin, Lin & Chu, Im, Pesaran & Shin, ADF-Fisher). Moreover, the Hausman test suggested fixed effects for the developed country sample and random effects for emerging markets. This reinforces our approach of splitting the sample into two homogenous groups to avoid masking any structural differences in their economies. We also tested the validity of our results by replacing risk aversion with the NATIXIS risk indicator (Table 1 attached). Our model for the entire sample shows that the budget balance and GDP per capita are statically significant and have the expected signs. A 1pp increase in the budget balance reduces the CDS level by 13.7% (column 1). In developed countries, the CDS reduction is 14.3% (column 2) versus 6% for emerging countries (column 3). With regard to the CDS average for developed countries (78.5 bps) and emerging markets (225.7bps), this corresponds to 11.2bps and 13.5bps, respectively.

Smith R. (2001), Estimation and inference with non-stationary panel time-series data, Department of Economics, Birkbeck College, London.
Flash 2011 - 751 - 7

Meanwhile, a 1pp rise in GDP growth per capita produces a 2% reduction in the CDS level on the sample average (154bps), i.e. around 3bps. We remind readers that since 2008, growth has been particularly fragile in the G7 and peripheral countries. The impact of the real effective exchange rate depends on the sample studied. While we do not obtain the expected sign for all countries, our two separate subgroups reveal the reasons for this. In developed countries, a 10% rise in the real effective exchange rate (loss of competitiveness) produces an 18% increase in the CDS level, as should be the case. However, in emerging countries, a loss of competitiveness is not synonymous with a rise in CDS, but rather a reduction of them. This relationship is in line with Balassa-Samuelson effects for catch-up countries and emerging exporting countries improved terms of trade on raw materials. Inflation, governance and risk aversion have the expected impact on CDS. A 1pp rise in inflation raises the CDS level by 4%, while a 1pt deterioration in governance leads to a 0.9% increase in the CDS level, i.e. 6bps and 1bps respectively. Lastly, a 10% rise in risk aversion produces a 16% rise in the CDS level. It is worth noting that the impact of risk aversion and inflation on CDS is greater in emerging countries than developed ones (Chart 3a). To identify the factors that guided CDS between January 2004 and August 2011, we multiply the coefficients of our estimate for all countries (column 1) by the average for each variable. This calculation proves that the variation in CDS is linked, almost in equal measures, via the fundamentals (52%) and the market variables (48%). This breakdown is similar to other empirical studies on sovereign spreads (Hartelius 20087, Baldacci 20118). However, the importance of the budget balances role as a fundamental variable (Chart 3b) reveals that current sovereign pressure is essentially due to the unprecedented deterioration in developed countries public finances.
Chart 3a Im pact on CDS (bp)

40 30 20 10 0 -10 -20 -30 -40

40 30 20 10 0

Chart 3b Bre ak dow n of CDS variation (bp) be tw e e n January 2004 & Augus t 2011

GDP per capita

Fundamentals

Governance

So urces: Dat ast ream, NA TIX IS

-50 A ll

Developed

Emerging

Hartelius K., Kashiwase K. and L. Kodres (2008): Emerging Market Spread Compression: Is it Real or is it Liquidity?, IMF Working Paper 08/10 8 Baldacci E., Salvatore D. and T. Poghosyan (2011), Spatial Spillovers in Emerging Market Spreads, IMF Working Paper 11/221.
Flash 2011 - 751 - 8

Budget balance

Inflation

V IX REER Governance Inf lation GDP per capita Budget balance

-10 REER -20

Sources: Dat ast ream, NA TIX IS

VIX

Summary: public finances are central to CDS

Against the backdrop of sovereign stress, we examine the role of macroeconomic and financial variables in the rise in sovereign CDS for a sample of 37 countries between January 2004 and August 2011. To do so, we estimate a random and fixed-effect panel to explain sovereign CDS. We also divide our sample into 18 developed countries and 19 emerging markets to reveal their specific characteristics. Our results show that: the fundamental variables used present the expected signs and effects, namely a deterioration in public finances, a reduction in GDP growth per capita, rising inflation, a loss of competitiveness (except in emerging countries) and a deterioration in governance, which all lead to a rise in sovereign CDS; the budget balance the highest explanatory power of all fundamental variables both in emerging and developed countries; the global variable also plays a decisive role, with a 10% hike in risk aversion producing a 16% rise in the CDS level across the sample, which corresponds to 24bps; the impact of risk aversion and inflation is much greater on emerging countries CDS than on those of developed countries.

The CDS variation over the period of study can be explained equally well by the fundamentals (52%) and the market variables (48%). The importance of the primary budgets role as a fundamental variable shows that current sovereign pressure is largely due to the unprecedented deterioration in developed countries public finances. Appendix
Table 1: Pane l e s tim ate s (de pe nde nt var iable log of CDS) De ve lope d countr ie s V ar iable Budge t balance (% of GDP) GDP pe r capita (r e al, YoY %) Inflation (YoY %) Gove r nance (pts ) REER (log) NATIXIS r is k indicator (log) Cons tant Number of countries Number of periods Number of observations Hausman test* R2 adjusted Levin, Lin & Chu test* Im, Pesaran & Shin test* A DF-Fisher test* 1 -19,85
(0.85)

Em e r ging countr ie s 9 -8,06

(0.80)

-5,94
(0.30)

-2,71
(0.18)

13,63
(1.53)

5,26
(0.68)

1,95
(0.31)

0,54
(0.09)

3,58
(0.37)

-0,89
(0.15)

0,79
(0.04)

0,53
(0.03)

-25,37
(1.90)

0,34
(0.77)

18 91 1637 Fixed ef f ects 0,69 Oui Non Non

18 91 1636 Random ef f ects 0,40 Oui Non Oui

So urc e: N atixis, Standard dev iatio n in parentheses * Significant to 5%, (Yes = unit ro o t, N o = no unit ro o t)

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AVERTISSEMENT / DISCLAIMER
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Natixis is authorised by the ACP in France and subject to limited regulation by the Financial Services Authority in the United Kingdom. Details on the extent of our regulation by the Financial Services Authority are available from us on request. Natixis is authorised by the ACP and regulated by the BaFin (Bundesanstalt fr Finanzdienstleistungsaufsicht) for the conduct of its business in Germany. The transfer / distribution of this document in Germany is done by / under the responsibility of NATIXIS Zweigniederlassung Deutschland. Natixis is authorised by the ACP and regulated by Bank of Spain and the CNMV for the conduct of its business in Spain. Natixis is authorised by the ACP and regulated by Bank of Italy and the CONSOB (Commissione Nazionale per le Societ e la Borsa) for the conduct of its business in Italy. This research report is solely available for distribution in the United States to major U.S. institutional investors as defined by SEC Rule 15(a)(6). This research report has been prepared and reviewed by research economists employed by Natixis (Paris). These economists are not registered or qualified as research economists with the NYSE and/or the NASD, and are not subject to the rules of the FINRA

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