The Impact of Government Interventions on CDS and Equity Markets
69 Pages Posted: 23 Mar 2010 Last revised: 19 Nov 2012
Date Written: November 1, 2012
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 of debt and equity in rescue measures, which tend to favor creditors. The discrepancies are driven by several factors including firm size, default correlation, and high ratings, thus corroborating our too-big-to-fail hypothesis.
Keywords: Credit risk, Financial crisis, Systemic risk, Too big to fail
JEL Classification: G01, G12, G14, G18
Suggested Citation: Suggested Citation