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FRM Part II · FRM Exam Part II · Country Risk: Determinants, Measures, and Implications

Which of the following is a recognised limitation of using sovereign CDS spreads as a measure of country risk?

A recognised limitation is that sovereign CDS markets can be thin and spreads can be driven by global risk appetite, hedging and speculative flows rather than just country fundamentals. They are traded market prices, observed frequently, not set by rating agencies or published annually.

  1. ALiquidity can be thin and spreads can reflect market-wide risk appetite and speculative demand rather than purely country fundamentalsCorrect
  2. BSovereign CDS spreads are available only once a year
  3. CSovereign CDS spreads cannot respond to changes in the economy
  4. DSovereign CDS spreads are set by rating agencies

Explanation

CDS spreads are market prices, observed frequently and responsive to news. Their drawbacks include thin liquidity for some sovereigns and contamination by risk premia, risk appetite and speculative or hedging demand. The other options misstate how they are set and observed.

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