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The paper investigates the relative pricing of the sovereign credit risk, for European countries, during and after the sovereign debt crisis of 2010-2012. We investigate empirically the theoretical relationship between CDS spreads and bond yields before and after the announcement of the Outright Monetary Transaction (OMT) Programme, by the European Central Bank, and we show that the relative mispricing of the sovereign credit risk has strongly reduced after the announcement of the OMT. We disentangle the effects of the ECB intervention on the sovereign debt market in different ways, and we provide evidence that the consistent relationship between default risk and bond yields across the Eurozone countries was restored after the ECB intervention. We show that the relative mispricing in the sovereign credit risk has generated arbitrage opportunities before the OMT announcement across all European countries. Nonetheless the arbitrage opportunities were not profitable because of high transaction costs. Following the ECB intervention, instead, we estimate a strong reduction in the transaction costs for the Eurozone countries only; therefore the arbitrage opportunities were cleared, and the equilibrium condition in the Eurozone sovereign debt market was restored.

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