Do Banks' Overnight Borrowing Rates Lead Their CDS Price? Evidence from the Eurosystem

58 Pages Posted: 23 Jun 2015

See all articles by Eero Tölö

Eero Tölö

Bank of Finland - Financial Markets

Esa Jokivuolle

Bank of Finland, Research Unit

Matti Viren

Bank of Finland - Research

Date Written: June 22, 2015

Abstract

We construct a measure of a bank’s relative creditworthiness from Eurosystem’s proprietary overnight loan data: the bank’s “average overnight borrowing rate spread, relative to overnight rate index” (AOR). We investigate the dynamic relationship between the AOR and the credit default swap spread (CDS) of 60 banks in years 2008-2013. We find that in daily differences the AOR leads the CDS at least by one day. The lead is concentrated on days of market stress for banks which mainly borrow from “relationship” lender banks. Such borrower banks are typically smaller, have weak ratings, and likely reside in crisis countries. In longer differences, up to several weeks, both the AOR and the CDS have some predictive power over one another. In sum, overnight borrowing rates may provide additional early-warning indications on certain banks’ deteriorating financial health over and above bank CDS spreads.

Keywords: credit default swaps (CDS); early-warning indicators; Eurosystem; leadlag relationship; money markets; overnight borrowing rates; TARGET2

JEL Classification: G01, G14, G21

Suggested Citation

Tölö, Eero and Jokivuolle, Esa and Viren, Matti, Do Banks' Overnight Borrowing Rates Lead Their CDS Price? Evidence from the Eurosystem (June 22, 2015). ECB Working Paper No. 1809, Available at SSRN: https://ssrn.com/abstract=2621625 or http://dx.doi.org/10.2139/ssrn.2621625

Eero Tölö (Contact Author)

Bank of Finland - Financial Markets ( email )

P.O Box 160
FIN-00101 Helsinki
Finland

Esa Jokivuolle

Bank of Finland, Research Unit ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2309 (Phone)

HOME PAGE: http://www.bof.fi/en/suomen_pankki/organisaatio/asiantuntijoita/jokivuolle_esa/

Matti Viren

Bank of Finland - Research ( email )

P.O Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2563 (Phone)
+358 10 831 2294 (Fax)

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