Bank Use of Sovereign CDS in the Eurozone Crisis: Hedging and Risk Incentives

53 Pages Posted: 1 Dec 2016 Last revised: 23 Sep 2018

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Yalin Gündüz

Deutsche Bundesbank

Timothy C. Johnson

University of Illinois at Urbana-Champaign

Date Written: November 16, 2016

Abstract

Using a comprehensive dataset from German banks, we document the usage of sovereign credit default swaps (CDS) during the European sovereign debt crisis of 2008-2013. Banks used the sovereign CDS market to extend, rather than hedge, their long exposures to sovereign risk during this period. Lower loan exposure to sovereign risk is associated with greater protection selling in CDS, the effect being weaker when sovereign risk is high. Bank and country risk variables are mostly not associated with protection selling. The findings are driven by the actions of a few non-dealer banks which sold CDS protection aggressively at the onset of the crisis, but started covering their positions at its height while simultaneously shifting their assets towards sovereign bonds and loans. Our findings underscore the importance of accounting for derivatives exposure in building a complete picture and understanding fully the economic drivers of the bank-sovereign nexus of risk.

Keywords: Credit derivatives, Credit default swaps, Sovereign credit risk, Eurozone, Sovereign debt crisis, Depository Trust and Clearing Corporation (DTCC).

JEL Classification: G01, G15, G21, H63

Suggested Citation

Acharya, Viral V. and Gündüz, Yalin and Johnson, Timothy C., Bank Use of Sovereign CDS in the Eurozone Crisis: Hedging and Risk Incentives (November 16, 2016). Available at SSRN: https://ssrn.com/abstract=2875323 or http://dx.doi.org/10.2139/ssrn.2875323

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yalin Gündüz (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Timothy C. Johnson

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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