The Market-Implied Probability of European Government Intervention in Distressed Banks

34 Pages Posted: 12 Oct 2016 Last revised: 10 Dec 2016

Richard Neuberg

Columbia University - Department of Statistics

Paul Glasserman

Columbia Business School

Benjamin S. Kay

U.S. Treasury Office of Financial Research

Sriram Rajan

Government of the United States of America - Office of Financial Research

Date Written: December 9, 2016

Abstract

New contract terms for credit default swaps (CDS) on banks were introduced in 2014 to cover losses from government intervention and related bail-in events. For many large European banks, CDS spreads are available under both the old and new contract terms; the difference (or basis) between the two spreads measures the market price of protection against losses from certain government actions to resolve distressed banks. We investigate cross-sectional and time series properties of this basis, relative to each bank’s CDS spread. We interpret a general decline in the relative basis as a market price-based signal that governments are less likely to bailout banks in distress, but that banks do not yet have sufficient bail-in debt to protect senior bond holders in case of a credit event.

Keywords: Credit Default Swaps, Banks, Government Intervention, European Bank Resolution

Suggested Citation

Neuberg, Richard and Glasserman, Paul and Kay, Benjamin S. and Rajan, Sriram, The Market-Implied Probability of European Government Intervention in Distressed Banks (December 9, 2016). OFR WP 16-10; Columbia Business School Research Paper No. 16-73. Available at SSRN: https://ssrn.com/abstract=2851177

Richard Neuberg (Contact Author)

Columbia University - Department of Statistics ( email )

Mail Code 4403
New York, NY 10027
United States

Paul Glasserman

Columbia Business School ( email )

3022 Broadway
403 Uris Hall
New York, NY 10027
United States
212-854-4102 (Phone)
212-316-9180 (Fax)

Benjamin S. Kay

U.S. Treasury Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States
202-927-8149 (Phone)

Sriram Rajan

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

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