Academic journal article Business: Theory and Practice

Analysing Sovereign Credit Default Swaps of Baltic countries/Baltijos Saliu Kredito Apsikeitimo Sandoriu Analize

Academic journal article Business: Theory and Practice

Analysing Sovereign Credit Default Swaps of Baltic countries/Baltijos Saliu Kredito Apsikeitimo Sandoriu Analize

Article excerpt


The Baltic countries--Estonia, Latvia and Lithuania declared their independence in 1990. After collapse of the Soviet Union in 1991 the Baltic countries were recognised as sovereign by the broad international community. With a very similar starting point, the countries chose an independent way of development. Following a hangover from a purely administrational system of political and economic fundamentals, the countries took a way to a democratic political system based on market economy principles. Market economy creates new challenges, and management of the countries' risk is one of them.

A natural way of development of the Baltic countries has been tightening links with Western countries. Joining the European Union (EU) in 2004 was a new step of the Baltic countries to strengthening ties with Western countries and Nordic countries in particular. Introduction of the euro was the next step towards integration. Entering the eurozone was not unified. Latvia joined the eurozone in 2014 following Estonia which became the eurozone member in 2011. Lithuania is going to introduce the euro in 2015.

Despite a common recent history of the Baltic countries they have several differences. Fiscal policy and development of the stock of sovereign debt are very different in these countries. Historically, Estonia follows consolidated fiscal policy and consequently the sovereign debt of the country is the lowest in the EU (1), whereas Latvia and Lithuania run a budget deficit. The budget deficit of Latvia and Lithuania reached 9.8 and 9.4 percent of the GDP in 2009 (European Commission 2014).

The world financial crisis of 2008 seriously shocked economies of the Baltic countries. These countries were the first in the EU, affected by the global credit crises. After continuous fast growth of economy the real GDP growth dropped by 14.1 percent for Estonia, 14.7 percent for Lithuania and 17.7 percent for Latvia in 2009, according to Eurostat 2014. The credit crush followed by a dramatic drop of GDP caused problems in the financial sector of the Baltic countries. In 2008 Parex bank was nationalised in Latvia. Two banks in Lithuania were closed down in 2011 and 2013.

Since the bankruptcy of Lehman Brothers, the credit risk of sovereigns has attracted particular attention. Before this event, credit market had been focused on corporate credit risk. The sovereign debt of the developed countries had been treated as risk free. The default risk of emerging markets was treated as very low. Starting from September 2008, the credit risk of the sovereigns was reassessed fundamentally. The credit risk of the countries of the EU was revised by the market on the largest scale. Even stable Nordic countries having a triple A ratings faced a revision of their credit risk. The Credit Default Swap (CDS) of Sweden and Denmark reached 150 basis points (bps) in the beginning of 2009. The CDS spreads of the eurozone country--Finland--jumped to 80 bps. The credit risk of the Baltic countries increased at incredible scale. The Latvian CDS spreads reached 1050 bps and Lithuanian CDS jumped to 850 bps.

The aim of the article is to analyse sovereign CDS market of the Baltic countries from September 2008 to December 2013. The analysis of CDS spreads allows to some extent to study the credit risk of the countries. We investigate the level of commonalities and differences in credit risk of the Baltic countries in terms of CDS spreads. Our study reveals interdependence between CDS spreads of the Baltic countries and analyses a contagion effect of the change of CDS spreads. Driving forces for changes of CDS spreads are established. We applied principal component analysis, regression analysis, correlation analysis and Granger causality test methods.

The rest of the paper is structured as follows. Section 2 presents literature overview focusing on CDS as an indicator of credit risk. Section 3 discusses developments in the sovereign CDS market of the Baltic countries. …

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