Investors are increasingly using credit-default swaps to hedge against the possibility of developed nations defaulting on their debt.
The huge buildup of government debt via the fiscal stimulus programs these countries enacted during the financial crisis has investors worried.
They use credit-default swaps to hedge against their positions in the government bonds of these countries.
Trading volume in sovereign credit default swaps for the United States, United Kingdom and Japan has doubled in the past year. Credit default swaps (CDS) measure the cost to insure against government-bond defaults.
CDS volumes for Italy, whose debt to GDP ratio is expected to soar to a whopping 127 percent next year, now represent the highest for any country in the world, according to the Depository Trust & Clearing Corp.
Meanwhile CDS, volume for Russia, Brazil, Ukraine and Indonesia is flat or down a bit in the last year, as investors are less concerned about those countries.
“The biggest single risk hanging over the bond markets is the rapid rise in public debt in the industrialized world,” Gary Jenkins, head of fixed income research at Evolution, told the Financial Times.
“Governments need to take action to cut deficits and debt.”
In Japan, the price of hedging against losses on $10 million of the country’s bonds with credit-default swaps has more than doubled to $76,160 a year this month from August, Bloomberg reports.
That’s because the new government plans record spending and borrowing while tax revenue drops.
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