The Impact of Government Interventions on CDS and Equity Markets

61 Pages Posted: 13 Oct 2011 Last revised: 19 Sep 2012

See all articles by Frederic A. Schweikhard

Frederic A. Schweikhard

University of Oxford - Oxford-Man Institute of Quantitative Finance; University of Oxford - Said Business School

Zoe Tsesmelidakis

University of Oxford - Said Business School; University of Oxford - Oxford-Man Institute of Quantitative Finance

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2012

Abstract

We question the impact of government guarantees on the pricing of default risk in credit and stock markets and, using a Merton-type credit model, provide evidence of a structural break in the valuation of U.S. bank debt in the course of the 2007-2009 financial crisis, manifesting in a lowered default boundary, or, under the pre-crisis regime, in higher stock-implied credit spreads. A possible explanation is the asymmetric treatment for debt and equity from rescue measures that tend to favor creditors. The discrepancies are driven by several variables including firm size, default correlation, and high ratings, thus corroborating our too-big-to-fail hypothesis.

Keywords: Credit risk, Structural model, Financial crisis, Systemic risk, Too big to fail

JEL Classification: G01, G12, G14, G18, G21

Suggested Citation

Schweikhard, Frederic A. and Tsesmelidakis, Zoe and Tsesmelidakis, Zoe, The Impact of Government Interventions on CDS and Equity Markets (June 1, 2012). Finance Meeting EUROFIDAI - AFFI, Paris, December 2011 , AFA 2012 Chicago Meetings, Available at SSRN: https://ssrn.com/abstract=1943546 or http://dx.doi.org/10.2139/ssrn.1943546

Frederic A. Schweikhard

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

Zoe Tsesmelidakis (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

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