The Macro-Informational Role of Derivatives: Evidence from the Sovereign CDS Market

Sovereign CDS spreads have unique predictive power for future stock market index returns, sovereign bond yields, as well as real macroeconomic variables such as GDP and PMI. The predictive power comes almost entirely from the global, rather than country-specific, component of sovereign CDS spreads. This is consistent with the interpretation that the information advantage of the sovereign CDS market is from its “global perspective” rather than local knowledge about individual countries. Stock and sovereign bond market indices gradually “catch up” with sovereign CDS spreads, mostly during the days surrounding credit rating or outlook changes, and especially for downgrades.