Hedging and speculative strategies play
a key role in periods of financial market volatility particularly during
economic crises. In such contexts, liquidity problems tend to evolve into
potential credit risk events that amplifies the volatility of several markets
such as the CDS and the government bond markets. The former, however, generally
embodies a higher sensitivity to volatility due to the operatorsí uncertainty
about unstable and countercyclical counterparty risk. The aim of this paper is to analyze the
long-lasting dynamic relationship between credit default swap (CDS) premia and
government bond yield spreads (GBS), by focusing particularly on sovereign
credit risk, in order to evaluate the lead-lag markets in the price discovery
process against the backdrop of a deep financial crisis. The focus of this
study concerns the country of Italy, one of the major European countries that
suffers from both weak GDP growth and high public debt, which subjects it to
volatility and speculation during periods of financial stress.
JEL classification numbers: G01, G12, G14, G20.
Keywords: CDS spreads, Government bond spreads, Credit risk, Cointegration,
Vector error correction model, Granger-causality.