Sovereign CDS: Cat or canary?

Sovereign credit default swaps have become magnets for controversy amid worries about the condition of government finances. Does the market really reflect the probability of default and has too much attention been paid to it?

Critics of credit derivatives see a shadowy world in which market participants are able to profit from the miseries of companies and their employees. In some instances, they argue, dealers seek to push firms into bankruptcy for their own gain (Risk August 2009, pages 33–35). With the rise of trading in sovereign credit default swaps (CDSs), this nightmare has become darker still – now, whole countries are under threat of speculative attack from nefarious CDS traders.

In light of the shaky public