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

53 Pages Posted: 23 Aug 2018 Last revised: 21 Feb 2019

See all articles by Viral V. Acharya

Viral V. Acharya

Government of India - Reserve Bank of India

Yalin Gündüz

Deutsche Bundesbank

Timothy C. Johnson

University of Illinois at Urbana-Champaign

Date Written: 2018

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 (2018). Deutsche Bundesbank Discussion Paper No. 26/2018, Available at SSRN: https://ssrn.com/abstract=3237291

Viral V. Acharya (Contact Author)

Government of India - Reserve Bank of India

Bakery Junction Service Road
Vazhuthacaud
Thiruvananthapuram, Kerala 695033
India

Yalin Gündüz

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

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
63
Abstract Views
316
rank
375,679
PlumX Metrics