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Sovereign Default Risk, Overconfident Investors and Diverse Beliefs: Theory and Evidence from a New Dataset on Outstanding Credit Default Swaps

Janus, Thorsten and Jinjarak, Yothin and Uruyos, Manachaya (2013) 'Sovereign Default Risk, Overconfident Investors and Diverse Beliefs: Theory and Evidence from a New Dataset on Outstanding Credit Default Swaps.' Journal of Financial Stability, 9 (3). pp. 330-336.

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Abstract

In standard public finance theory a government’s cost of borrowing depends on the common beliefs held by rational investors regarding default risk. We advance understanding of the effects of diverse beliefs and overconfidence among investors in their ability to assess the sovereign’s creditworthiness. Theoretically, we find that demand for insurance against default is positively related to the absolute difference between the market price of sovereign risk and the risk forecasted by the economy’s fundamentals. We find preliminary support for this prediction in a newly available dataset on sovereign credit default swaps (CDSs): after controlling for the size of the public debt, the absolute size of the gap between the actual and forecasted spreads is positively related to the value of outstanding CDSs.

Item Type: Journal Articles
SOAS Departments & Centres: Faculty of Law and Social Sciences > School of Finance and Management
Faculty of Law and Social Sciences > School of Finance and Management > Centre for Financial and Management Studies (CeFiMS)
ISSN: 15723089
DOI (Digital Object Identifier): 10.1016/j.jfs.2012.11.007
Depositing User: Yothin Jinjarak
Date Deposited: 27 Nov 2012 09:26
URI: http://eprints.soas.ac.uk/id/eprint/14611

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