Credit Contagion from Counterparty Risk

46 Pages Posted: 29 Apr 2009

See all articles by Philippe Jorion

Philippe Jorion

University of California, Irvine - Paul Merage School of Business

Gaiyan Zhang

University of Missouri at Saint Louis - College of Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: July 1, 2008

Abstract

Standard credit risk models cannot explain the observed clustering of default, sometimes described as "credit contagion." This paper provides the first empirical analysis of credit contagion via direct counterparty effects. We examine the wealth effects of bankruptcy announcements on creditors using a unique database. On average, creditors experience severe negative abnormal equity returns and increases in CDS spreads. In addition, creditors are more likely to suffer from financial distress later. These effects are stronger for industrial creditors than financials. Simulations calibrated to these results indicate that counterparty risk can potentially explain the observed excess clustering of defaults. This suggests that counterparty risk is an important additional channel of credit contagion and that current portfolio credit risk models understate the likelihood of large losses.

Keywords: credit contagion, counterparty risk, portfolio credit risk models, default correlation, trade credit

JEL Classification: G14, G12, G33

Suggested Citation

Jorion, Philippe and Zhang, Gaiyan, Credit Contagion from Counterparty Risk (July 1, 2008). Available at SSRN: https://ssrn.com/abstract=1396733 or http://dx.doi.org/10.2139/ssrn.1396733

Philippe Jorion (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

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Irvine, CA 92697-3125
United States
949-824-5245 (Phone)
949-824-8469 (Fax)

Gaiyan Zhang

University of Missouri at Saint Louis - College of Business Administration ( email )

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487 SSB
St. Louis, MO 63121
United States

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