Regime Switching Determinants of Sovereign CDS Spreads: Evidence From Turkey

Abstract

In this study, it is assessed the main determinants of sovereign CDS spreads in Turkey from January 2006 to December 2015. Before delving into the nonlinear Markov regime-switching model estimation, a conventional one-state linear model is estimated answering to what extent the sovereign credit risk is affected in between global and country-specific market variables and by credit ratings announcement changes. In broad strokes, the regime-switching analysis reveals that among domestic variables, it is the foreign exchange rate that affects the sovereign credit risk more in more volatile periods and among global variables, the indicators standing for global volatility risk premiums and international liquidity primarily influence the changes in the sovereign CDS spread in turbulent regimes whereas proxies for global risk free rate are significant more in tranquil regimes.

How the macroeconomic conditions and the global risk factors affect sovereign CDS spreads? New Evidence from Turkey

“…According to Table 1, variations in sovereign CDS spreads are mainly explained by the nominal exchange rates (34.34 %). This result is consistent with the other studies in the literature (Hassan, Kayhan, and Bayat, 2017;Polat, 2017). The second most significant contribution to the fluctuations in sovereign CDS spreads is the industrial production index (9.55%).…”

“…According to Longstaff et al (2011:76) Turkey is in a high sovereign CDS spread position because of the macroeconomic instability during the past few years. Several attempts have been made to highlight the drivers of sovereign CDS spreads for Turkey (Kilci, 2017;Gebeşoğlu and Varlık, 2018;Şahin, 2018;Polat, 2017). In a recent study, Cihangir (2020) investigates the global and domestic variables that affect Turkey's sovereign CDS spreads between the 2009 and 2018 periods.…”