The Fundamental Determinants of Credit Default Risk for European Large Complex Financial Institutions

32 Pages Posted: 1 Feb 2011

See all articles by Inci Otker-Robe

Inci Otker-Robe

International Monetary Fund (IMF) - Monetary and Capital Markets Department; World Bank

Jiri Podpiera

International Monetary Fund (IMF)

Date Written: June 2010

Abstract

This paper attempts to identify the fundamental variables that drive the credit default swaps during the initial phase of distress in selected European Large Complex Financial Institutions (LCFIs). It uses yearly data over 2004-08 for 29 European LCFIs. The results from a dynamic panel data estimator show that LCFIs’ business models, earnings potential, and economic uncertainty (represented by market expectations about the future risks of a particular LCFI and market views on prospects for economic growth) are among the most significant determinants of credit risk. The findings of the paper are broadly consistent with those of the literature on bank failure, where the determinants of the latter include the entire CAMELS structure - that is, Capital Adequacy, Asset Quality, Management Quality, Earnings Potential, Liquidity, and Sensitivity to Market Risk. By establishing a link between the financial and market fundamentals of LCFIs and their CDS spreads, the paper offers a potential tool for fundamentals-based vulnerability and early warning system for LCFIs.

Suggested Citation

Ötker-Robe, İnci and Podpiera, Jiri, The Fundamental Determinants of Credit Default Risk for European Large Complex Financial Institutions (June 2010). Available at SSRN: https://ssrn.com/abstract=1750682 or http://dx.doi.org/10.2139/ssrn.1750682

İnci Ötker-Robe (Contact Author)

International Monetary Fund (IMF) - Monetary and Capital Markets Department ( email )

United States
202 623-7000 (Phone)
202 623-4661 (Fax)

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Jiri Podpiera

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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