What Determines Euro Area Bank CDS Spreads?

National Bank of Belgium Working Paper No. 190

38 Pages Posted: 23 Sep 2010 Last revised: 27 Sep 2010

See all articles by Jan Annaert

Jan Annaert

University of Antwerp Department of Accounting & Finance; University of Antwerp - Antwerp Management School

Marc J. K. de Ceuster

University of Antwerp - Faculty of Applied Economics - City Campus

Patrick Van Roy

National Bank of Belgium

Cristina Vespro

affiliation not provided to SSRN

Date Written: May 10, 2010

Abstract

This paper decomposes the explained part of the CDS spread changes of 31 listed euro area banks according to various risk drivers. The choice of the credit risk drivers is inspired by the Merton (1974) model. Individual CDS liquidity and other market and business variables are identified to complement the Merton model and are shown to play an important role in explaining credit spread changes. Our decomposition reveals, however, highly changing dynamics in the credit, liquidity, and business cycle and market wide components. This result is important since supervisors and monetary policy makers extract different signals from liquidity based CDS spread changes than from business cycle or credit risk based changes. For the recent financial crisis, we confirm that the steeply rising CDS spreads are due to increased credit risk. However, individual CDS liquidity and market wide liquidity premia played a dominant role. In the period before the start of the crisis, our model and its decomposition suggest that credit risk was not correctly priced, a finding which was correctly observed by e.g. the International Monetary Fund.

Keywords: credit default spreads, credit risk, financial crisis, financial sector, liquidity premia, structural model

JEL Classification: G01, G12, G21

Suggested Citation

Annaert, Jan and de Ceuster, Marc J. K. and Van Roy, Patrick and Vespro, Cristina, What Determines Euro Area Bank CDS Spreads? (May 10, 2010). National Bank of Belgium Working Paper No. 190. Available at SSRN: https://ssrn.com/abstract=1680765

Jan Annaert (Contact Author)

University of Antwerp Department of Accounting & Finance ( email )

Faculty of Applied Economics
Prinsstraat 13
Antwerp, B-2000
Belgium

HOME PAGE: http://https://www.uantwerp.be/en/staff/jan-annaert/

University of Antwerp - Antwerp Management School ( email )

Boogkeers 5
Antwerp, 2000
Belgium

Marc J. K. De Ceuster

University of Antwerp - Faculty of Applied Economics - City Campus ( email )

Office B-337
Prinsstraat 13
Antwerp, Antwerp 2000
Belgium
+ 32 3 220 41 24 (Phone)
+ 32 3 220 40 64 (Fax)

HOME PAGE: http://www.ua.ac.be/marc.deceuster

Patrick Van Roy

National Bank of Belgium ( email )

Brussels, B-1000
Belgium
+32 2 221 5333 (Phone)

Cristina Vespro

affiliation not provided to SSRN ( email )

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