Abstract

http://ssrn.com/abstract=1645798
 
 

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Credit Derivatives and the Default Risk of Large Complex Financial Institutions


Giovanni Calice


University of Birmingham - Department of Economics

Christos Ioannidis


University of Bath-Department of Economics

Julian M. Williams


University of Aberdeen Business School

2009

Paolo Baffi Centre Research Paper No. 2009-75

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.

Number of Pages in PDF File: 65

Keywords: distance to default, credit derivatives, credit default swap index, financial stability

JEL Classification: C32, G21, G33

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Date posted: July 21, 2010 ; Last revised: February 13, 2011

Suggested Citation

Calice, Giovanni and Ioannidis, Christos and Williams, Julian M., Credit Derivatives and the Default Risk of Large Complex Financial Institutions (2009). Paolo Baffi Centre Research Paper No. 2009-75. Available at SSRN: http://ssrn.com/abstract=1645798 or http://dx.doi.org/10.2139/ssrn.1645798

Contact Information

Giovanni Calice (Contact Author)
University of Birmingham - Department of Economics ( email )
JG Smith Building
Birmingham, B15 2TT
United Kingdom
Christos Ioannidis
University of Bath-Department of Economics ( email )
Claverton Down
Bath, BA2 7AY
United Kingdom
Julian M. Williams
University of Aberdeen Business School ( email )
Old Aberdeen
Aberdeen, AB24 3QY
United Kingdom
01224 272204 (Phone)
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