Credit derivatives and the default risk of large complex financial institutions

Giovanni Calice, Christos Ioannidis, Julian Williams

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    12 Citations (Scopus)

    Abstract

    This paper addresses the impact of developments in the credit risk transfer market on the viability of a group of systemically important nancial 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 conditions 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 the 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.
    Original languageEnglish
    Pages (from-to)85-107
    Number of pages23
    JournalJournal of Financial Services Research
    Volume42
    Issue number1
    Early online date26 Oct 2011
    DOIs
    Publication statusPublished - Oct 2012

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    Keywords

    • distance to default
    • credit derivatives
    • credit default swap index
    • G12
    • G13
    • G15

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