A Model to Test the Price Discovery of Sovereign Credit Risk in the Eurozone

This paper investigates the price discovery process of credit risk in Eurozone countries from 2008 to 2014 within the two interconnected Bond and Credit Default Swap markets. Subject of this analysis are the short-term and long-term dynamic relationship between the two time-series of credit spreads obtained from the Bond and CDS markets. The analysis allows determining which credit spread anticipates the other in pricing a certain Soveregn entity, because it is more efficient and timely to incorporate new credit information. The empirical evidence obtained in period characterized by different levels of credit risk and then associated to different volatility and liquidity conditions, suggests implications for practioners who want to take advantage of potential markets inefficiences and for policymakers interested in maintaining the stability of financial system through timely and correct responses to possible price shocks.