Journal of Emerging Market Finance

To study the role of elections in financial market instability, we focus on the role of credit risk pricing during elections from 2004 to 2007 in 13 emerging market economies. We use a unique dataset of daily credit default swap (CDS) pricing, with standard macroeconomic controls, to study the role of elections in prompting financial market instability and contagion. Sovereign CDS pricing provides a number of advantages in understanding emerging market instability of previous studies. First, the daily data allows a greater level of specificity than was used in previous credit market and political studies. Second, even though sovereign credit conditions change slowly, CDS pricing changes daily, reflecting sentiment or forward-looking beliefs. Third, the CDS allows us to focus on the perceived public credit risk of an election and the incoming government. Our study reveals a number of unique findings. First, investors price in additional risk for elections regardless of party, incumbency or size of win. Second, long- and short-term investors price risk very differently, with 1-year CDS investors reacting much more strongly to election risk, causing the overall spread between 10- and 1-year swaps to narrow. Third, our results provide continued support for the theory of investor herding in international financial markets, and a focus on a small number of economic variables in determining sovereign creditworthiness. Investors do not study the relative risk factors as much as price in structural risk by the existence of definable benchmarks like elections.

A new variance ratio is proposed in this article that utilises the extreme values of asset prices. On the basis of the specification test, it is documented that there is excess volatility in the Indian stock market, whereas this feature is completely absent in the US. It is also found that such excess volatility is persistent in India in the sense that it gives rise to excessive path dependence. Furthermore, it is shown how such path dependence can be modelled from a theoretical point of view by way of the Binomial Markov Random Walk model.

Given the vast growth in credit default swap (CDS) market over the last few years, a dramatic improvement is projected in pricing discovery of sovereign CDS as well as its interaction with the underlying bond markets. In this article, a recent comprehensive sample of 20 sovereign CDS spreads, along with their underlying bonds, is examined for the pricing equilibrium for emerging markets. On the basis of the tests of vector error correction model and Granger causality, and by comparing with prior studies, this article finds that sovereign CDS market has served as more significant tool in measuring sovereign credit risk than before.

This article examines several key global market conditions, such as a proxy for market uncertainty and measures of interbank funding stress, to assess financial volatility and the likelihood of crisis. Using Markov regime-switching techniques, it shows that the Lehman Brothers failure was a watershed event in the crisis, although signs of heightened systemic risk could be detected as early as February 2007. In addition, we analyse the role of global market conditions to help determine when governments should begin to exit their extraordinary public support measures.