Credit Risk Transfer and the Forecasting of Bank Defaults

61 Pages Posted: 21 Mar 2009 Last revised: 13 Jul 2009

See all articles by Giovanni Calice

Giovanni Calice

Bangor Business School

Christos Ioannidis

University of Bath-Department of Economics

Julian M. Williams

Durham Business School

Date Written: July 11, 2009

Abstract

The current financial crisis has brought into sharp focus the need for robust empirical analysis of bank default prediction models. The contagion currently affecting the banking sector has its roots in traditional banking crises, i.e. inflated asset valuations and poor risk management. The difference, however, between past crises and that which appears to have began in earnest in August 2007 is the presence of the credit derivatives (CDs) market. The transmission of credit risk via these types of instruments appears, according to international financial regulators, to have amplified the current global financial crisis by offering a direct and unobstructed mechanism for channeling defaults between financial institutions of a variety of types. This paper proposes a default risk model, in the vain of the classic Merton-type, which incorporates forward-looking measures of market and credit risk using the credit default swaps (CDS) market as a latent variable for forecasting asset volatility. We present a robust set of empirical tests to illustrate the effectiveness of this model over alternative specifications.

Keywords: Banks, Distance to Default, Credit Derivatives, Mutlivariate Volatility

JEL Classification: G21, C32, C51

Suggested Citation

Calice, Giovanni and Ioannidis, Christos and Williams, Julian M., Credit Risk Transfer and the Forecasting of Bank Defaults (July 11, 2009). Available at SSRN: https://ssrn.com/abstract=1364589 or http://dx.doi.org/10.2139/ssrn.1364589

Giovanni Calice

Bangor Business School ( email )

Bangor Business School
College Road
LL57 2DG
United Kingdom

Christos Ioannidis

University of Bath-Department of Economics ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Julian M. Williams (Contact Author)

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

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