Credit Default Swaps: Not All Noise

New paper from FRB Atlanta pointing out the fairly obvious: While sovereign credit default swaps are traders’ tinker toys, they aren’t completely divorced from changes in the underlying riskiness of countries debt. Good to see the case being made, however.

Spreads on credit default swaps for some countries’ sovereign debt have increased recently. Given the terms of CDS contracts, this increase in the spreads can be interpreted as a reflection of heightened concern about countries having difficulty making the promised payments. On the other hand, the increase in spreads could simply reflect mindless speculation on these countries’ debt.

A review of the Irish CDS spread indicates that CDS spreads have been reacting to news—about both Ireland and the European Union. Large changes in the Irish spread in late 2008 and in early 2009 reflected Irish developments, but later changes before September 2010 were associated with European Union developments. The Irish spread has been sensitive to news concerning Ireland and to news concerning Greece and the European Union’s responses to the Greek government’s difficulties.