7. Conclusion
The purpose of this study was to examine whether changes in sovereign credit default swap
premiums were able to predict stock market or currency market crises in emerging markets. The
logistic regression results show that the one month change in a country CDS premium tends to
increase one month ahead of a crisis in the stock market, while it does not have a significant
implication for the currency market. Also, the predictive power was satisfactory for stock market
crises. By contrast, these financial instruments were found to be insignificant in presence of other
factors in explaining currency crises. The findings here confirm the results from Cudert and Cox
(2007) that factors that measure investor sentiment have more predictive power in stock market crises
than in currency crises. The inclusion of such a financial instrument as a factor in models that predict
financial crises and its ability to improve predictions in stock market crises is the major contribution
of this study in the existing literature. We established that fluctuations in CDS premiums signal
trouble in stock markets.
Recently, because of the critiques directed to the industry for the low level of transparency in
the CDS market, The Depository Trust & Clearing Corp. has decided to publish quotes of CDS online
and free for public. It will be interesting to see whether this move will have an effect on the crises
predictive ability of these instruments in the future. This issue is beyond the scope of this study;
however, the informational value of these financial instruments is without doubt immense.
8. References:
[1] Boucher, Cristophe, (2005), Stock Prices, Inflation and Stock Return Predictability, Social Science
Research Network.
[2] Chan-Lau, Jorge A.; Yoon Sook, Kim, (2004), Equity Prices, Credit Default Swaps, and Bond
Spreads in Emerging Markets, IMF Working Paper WP/04/27.
[3] Cochrane, John, (2005), Money as stock, in: Journal of Monetary Economics, 52, pp. 501 - 528.
[4] Coudert, Virgine; Gex, Mathieu, (2006), Can risk aversion indicators anticipate financial crises,
Banque de France, in: Financial Stability Review, 9.
[5] Duffie, Darrell., (1999), Credit Swap Valuation, in: Financial Analysts Journal, 55, pp. 73 - 87.
[6] Im, Kyung So; Pesaran, Hashem M., (2003), On the Panel Unit Root Tests Using Nonlinear
Instrumental Variables, Cambridge Working Papers in Economics, 0347.
[7] Kaminsky, Graciela; Reinhart, Carmen M., (1996), The Twin Crises: The Causes of Banking and
Balance ofPayments Problems, in: The American economic Review, 89, pp. 473 - 500.
[8] Kaminsky, Graciela; Lizondo, Saul; Reinhart, Carmen M., (1998), Leading Indicators of Currency
Crises, IMF Working Paper 97/79.
[9] Kumar, Mohan; Moorthy, Uma; Perraudin, William, (2003), Predicting emerging market currency
crashes, in: Journal ofEmpirical Finance, 10, pp. 427 - 454.
[10] Mishkin, Frederic S.; White, Eugene N., (2002), U.S. Stock Market Crashes and their Aftermath:
Implications for Monetary Policy, NBER Working Paper 8992.
[11] Packer, Frank; Chamaree, Suthiphongchai, (2003), Sovereign credit default swaps, in: BIS
Quarterly Review, pp. 79 - 88.
[12] Peltonen, Tuomas A., (2006), Are Emerging Market Currency Crises Predictable, European
Central Bank, Working Paper Series, 571.
[13] Sachs, Jeffrey; Tornell, Aaron; Velasco, Andres, (1996), Financial Crises in Emerging Markets:
The Lessons from 1995, Brooking Papers on Economic activity 1.
136