European union debt crisis and credit default swaps in light of the global financial crisis

Abstract

European union debt crisis and credit default swaps in light of the global financial crisis In this study, the effect of 2008 financial crisis on European Union's public debt and the relationship between European Union debt crisis and credit default swaps are analyzed. Because it contains complex and high-volume derivative products, 2008 crisis differs from other crises. Credit default swaps which is the most traded product in derivatives market, is an agreement that buyer of the credit default swaps makes a payment with certain maturities to the seller who will compensate the buyer in the event of a loan default. There is a positive relationship between debt default risk of a country and credit default swaps. In this study, 14 European Union member country's credit default swap rates and Public Debt/GDP rates relationship are examined by panel data analysis for the period 2004:Q1-2011:Q2. In addition, in order to see the effect of 2008 financial crisis, a "financial crisis index" is calculated and included in the model as an explanatory variable. According to the estimation results of Fixed Effect Model, one unit increase in the Public Debt/GDP ratio increases credit default swaps by 11.9 units and one unit increase in financial crisis index increases credit default swaps by 5.6 units.