From volatility to stability: understanding the role of macroeconomic factors in sovereign CDS spreads

Abstract

This paper contributes to the understanding of sovereign credit default swap (CDS) markets by examining the response of CDS spreads to macroeconomic factors and exploring extreme value dependence and its relation to economic cycles. The study focuses on four emerging countries in the Asia–Pacific sovereign CDS markets from 2009 to 2023 and utilises a dynamic quantile autoregressive distributed lag (QARDL) approach to account for statistical stylized facts. The findings reveal significant relationships between economic growth, inflation, volatility index (VIX), interest rates and real effective exchange rate on CDS spreads, with varying effects across quantiles and countries. Additionally, the study explores the impact of economic expansion and contraction on CDS spreads, highlighting the significant negative effects of the expansion in certain countries and the positive impacts of contraction phases. These findings provide valuable insights for policymakers in risk management and policy decision-making, emphasizing the need for policies that promote sustainable growth; manage market risks during volatile periods and consider the implications of interest rates, exchange rates and economic phases on financial stability. The empirical model used is evaluated for dynamic stability, and policy implications are discussed in light of the research outcomes.