Anne-Laure Delatte, Associate Professor, Rouen Business School, 23 Jul 2012, VoxEU
Uncovered sovereign credit default swaps will be permanently prohibited in the EU by November 2012. While empirical evidence on their destabilising role is mounting, this column argues that the EU regulation will have only a limited effect, as a number of inconsistencies create regulatory arbitrage and opportunities to circumvent the ban.
...We find that the markets of sovereign and banking CDSs have played a dominant role in driving market sentiment. In fact, we find that for the same level of fundamentals, investors require a higher interest rate when CDSs premia are high. Within a market environment filled with uncertainty and imperfect information, the CDS market transmits a market signal that leads market participants to believe that other participants “know something”...
...Accounting for shifts in market sentiment explains the sudden eruption of the crisis in countries like Portugal or Spain, where the fundamentals have deteriorated only progressively...
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