recent global financial crisis and the subsequent sovereign debt crisis of the
Eurozone peripheral countries have generated historic levels of volatility and
instability in the financial markets. In particular, during the sovereign debt
crisis market operators have begun to focus on the so-called “redenomination
risk”, that is the hypothesis of exit from the EMU (Euro Monetary Union) by one
or more countries and the consequent redenomination of their debt in the past
national currency. This type of risk constitutes a form of additional credit
risk premium due to expected systemic failure of the Eurozone. The effects of
the economic-financial crisis, the weak economic growth and the political
instability that have characterized especially the Italian system in recent years
provide the ideal starting point to analyze the evolution of the redenomination
risk in the pricing process of the Italian banks’ CDSs (Credit Default Swaps). The
contribution of this work is to evaluate the dynamic evolution of sovereign and
redenomination risk in the price discovery process of the Italian banks’ CDS
spreads (or premia) by using rolling window regressions. Results show that
redenomination risk explains a great part of the variance in the CDS spreads
during periods of financial distress. The sovereign risk component explains a
large part of the variance for almost the entire considered period.
Classification: G01, G12, G14, G20.
Keywords: CDS spreads, Sovereign risk, Redenomination
risk, Rolling window regressions, ISDA basis.