The Term Structure of CDS Spreads and Sovereign Credit Risk

The shape of the term structure of credit default swap spreads is an informative signal about the relative importance of global and domestic risk factors to the time variation of sovereign credit spreads. Using a geographically dispersed panel of 44 countries, I show that the relative importance of global and country-specific risk in explaining sovereign credit risk varies with the sign of the slope of the term structure and the duration of its inversion. A model rationalizes how global shocks determine spread changes when the slope is positive, while a negative slope signals that domestic shocks are relatively more important