FINANCIAL MARKET REACTION TO CHANGES IN THE VOLATILITIES OF CDS RETURNS

The dynamics of the CDS sovereign instrument provides important information about the evolution of country risk as it is perceived by the financial markets. Therefore, if regime changes in these dynamics would signal a shift in investors' perceptions, such a change appearing simultaneously in more than one country, would flag the existence of contagion. This paper uses a methodology that relies on the identification of moments when regime shifts in the volatilities of CDS returns are realized simultaneously and uses these dates in an event study to quantify the reaction of three types of European financial assets to these common regime changes. Our approach showed that such reactions are found for each group of assets: foreign exchange rates, stock indices and bonds.