Credit Derivatives and the Default Risk of Large Complex Financial Institutions
65 Pages Posted: 21 Jul 2010 Last revised: 13 Feb 2011
There are 4 versions of this paper
Credit Derivatives and the Default Risk of Large Complex Financial Institutions
Credit Derivatives and the Default Risk of Large Complex Financial Institutions
Credit Derivatives and the Default Risk of Large Complex Financial Institutions
Credit Derivatives and the Default Risk of Large Complex Financial Institutions
Date Written: 2009
Abstract
This paper addresses the impact of developments in the credit risk transfer market on the viability of a group of systemically important financial institutions. We propose a bank default risk model, in the vein of the classic Merton-type, which utilizes a multi-equation framework to model forward-looking measures of market and credit risk using the credit default swap (CDS) index market as a measure of the global credit environment. In the first step, we establish the existence of significant detrimental volatility spillovers from the CDS market to the banks' equity prices, suggesting a credit shock propagation channel which results in serious deterioration of the valuation of banks' assets. In the second step, we show that substantial capital injections are required to restore the stability of the banking system to an acceptable level after shocks to the CDX and iTraxx indices. Our empirical evidence thus informs the relevant regulatory authorities on the magnitude of banking systemic risk jointly posed by CDS markets.
Keywords: distance to default, credit derivatives, credit default swap index, financial stability
JEL Classification: C32, G21, G33
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Innovations in Credit Risk Transfer: Implications for Financial Stability
-
Credit Derivatives, Disintermediation and Investment Decisions
-
Credit Risk Transfer and Contagion
By Franklin Allen and Elena Carletti
-
By Franklin Allen and Douglas M. Gale
-
Systemic Risk in the Financial Sector: An Analysis of the Subprime-Mortgage Financial Crisis
-
Credit Risk Transfer and Financial Sector Performance
By Wolf Wagner and Ian W. Marsh
-
Credit Risk Transfer and Financial Sector Performance
By Wolf Wagner and Ian W. Marsh
-
Default Risk Sharing between Banks and Markets: The Contribution of Collateralized Debt Obligations
By Guenter Franke and Jan Pieter Krahnen