Global risk spillover and the predictability of sovereign CDS spread: International evidence

•We document strong evidence of Granger causality in mean from VIX to the CDS market in 98% of the countries examined.•Tests under conditional heteroscedasticity provide evidence of the spillover effect in mean, variance and value-at-risk.•The spillover is much stronger during the recent financial crisis.•Out-of-sample tests indicate that VIX is a significant factor in predicting sovereign CDS spreads.

Using an error correction model, we document strong evidence of Granger causality in mean from the S&P option market to the sovereign CDS market in 98% of the 56 sovereigns we investigate. Tests under conditional heteroskedasticity provide further evidence of the risk spillover effect from the S&P index option market to the CDS market in mean, variance, and value-at-risk. The strong spillover effect during the recent financial crisis implies that global shocks first affect the S&P option market and then spill over to the sovereign CDS market. We demonstrate that our results are quite robust.