DATA DESCRIPTION

The analysis uses CDS spreads to capture credit default risk of an institution, or the government. Studies have shown that CDS spreads can measure investors’ risk preference. According to Hull et al. (2004), both changes and levels of CDS spread contain significant information in estimating the probability of rating events, but CDS spread changes conditional on rating events, and downgrade announcements and negative outlooks do not have helpful information. Ismailescu and Kazemi (2010) analyse the relationship between the sovereign CDS spreads and the sovereign credit ratings, and show that investors can make decisions according to the same public information that would lead to the changes in CDS spreads prior to a rating announcement. Düllmann and Sosinska (2007) analyse the CDS spreads of banks, and document that banks’ CDS spreads indicate banking credit risk from three risk sources including idiosyncratic risk, systematic risk and liquidity risk.

36 selection of financial institution and sovereign CDS series was restricted by data availability. 10 Eurozone countries are analysed, including Austria (AT), Belgium (BE), France (FR), Germany (DE), Greece (GR), Ireland (IE), Italy (IT), Netherlands (NL), Portugal (PT), and Spain (ES) (see Panel A of Appendix 3)8, together with their domestic financial institutions (40 financial institutions in total, see Panel B of Appendix 3). The CDS series of the financial institutions are chosen according to the Standard Industrial Classification (SIC) code of the institutions (major groups 60-67, including Finance, Insurance, and Real Estates), respectively. Most of the financial sector constituents of the iTraxx Europe index (13 out of 25) are covered by the data set, which indicates that the financial institutions chosen are representative of the financial sectors of these Eurozone countries.

The study uses five-year CDS, since it is the largest and the most liquid constituent of the CDS markets. The restructuring type of the sovereign CDS series is Complete Restructuring (CR), as it is the only restructuring clause applied by the sovereign CDS series. The restructuring type of the financial institutions is “Modified-Modified” (MM) Restructuring. The former restructuring clause, Modified Restructuring (MR), had been too severe in its limitation of 60-month deliverable obligations, and the MM restructuring clause has been introduced and applied by the European market participants since 2003.

The data set used to test the first Greek bailout starts from 13 November 2007 until 17 February 2012. The Greek CDS series stops on 17 February 2012, after Greek debt restructuring triggered approximately $3.2bn CDS credit protection payout on Greek sovereign debt in early March 2012. The CDS series for other countries extends until 08 October 2012.

8

We intend to cover the 17 Eurozone guarantees of the EFSF, from which Cyprus, Estonia, Slovakia, and Slovenia are excluded because of no data of corporate CDS series available, Luxemburg is excluded as no data of sovereign CDS series provided, Malta is excluded as neither corporate nor sovereign CDS series available, and Finland is excluded because of no CDS series data of financial institutions available.

37 The study investigates the interdependence of the sovereign and the financial institution CDS series in two sub-periods. The first stage starts from 13 November 2007 until 7 May 2010 and contains 649 observations for each CDS series. On 9 May 2010, the European Financial Stability Facility (EFSF) set out the first bailout package to Greece worth up to €750 billion aimed at rescuing financial stability across the European countries. The second stage starts from 10 May 2010 after the first rescue package set out, and it ends on 17 February 2012 before the second bailout package worth €130 billion approved by the Eurozone countries together with the IMF and the Institute of International Finance.

The dataset has been separated into two groups. One group includes the countries that have requested for the bailout funding from the EFSF or have been facing severe default risk, i.e., Greece, Ireland, Italy, Portugal and Spain (GIIPS). The other group is constituted of the other guarantees of the EFSF that have contributed the most to the bailouts, i.e., Austria, Belgium, France, Germany and Netherlands (non-GIIPS).

Figure 3.1 shows the sovereign CDS spreads for each of the ten countries in the sample. The bailout periods for Greece (first (G1) and second (G2) bailouts), Ireland (I) and Portugal (P) are displayed. Before February 2010, the sovereign CDS spreads of all the countries remain low and stable. The sovereign CDS spreads of the GIIPS countries continue to increase after the first Greek bailout (G1). But since the second Greek bailout (G2), except the Greek sovereign CDS spreads remaining high, the sovereign CDS spreads of the other four countries have started to come down.

[Insert Figure 3.1]

Panel A, B and C of Figure 3.2 visually display the co-movement of the sovereign CDS spreads and the CDS spreads of domestic financial institutions in Greece, Ireland and Portugal, respectively. The CDS spreads of the institutions increase after

38 the Greek first bailout (G1) reaching the peak at the second Greek bailout (G2).

[Insert Figure 3.2]

Appendix 4 shows the summary statistics of the CDS spreads of the sovereign debts and the financial institutions for the ten countries. In general, the sovereign CDS spreads of the GIIPS countries are much higher than the sovereign CDS spreads of non-GIIPS countries, which indicates that the GIIPS countries have been suffering severe sovereign default risk during the Eurozone crisis.