The Fundamental Determinants of Credit Default Risk for European Large Complex Financial Institutions
IMF Working Paper WP/10/153
32 Pages Posted: 10 Apr 2011
Date Written: June 2010
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.
Keywords: Large Complex Financial Institutions, dynamic panel data, Credit Default Swap, CAMELS, vulnerability analysis, early warning systems
JEL Classification: G21, G28, C12
Suggested Citation: Suggested Citation