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Credit derivatives and the default risk of large complex financial institutions

Calice, Giovanni, Ioannidis, Christos and Williams, Julian (2010) Credit derivatives and the default risk of large complex financial institutions , Milano, IT Paolo Baffi Centre (Paolo Baffi Centre Research Paper, 2009-75).

Record type: Monograph (Working Paper)

Abstract

This paper addresses the impact of developments in the credit risk transfer market on the viability of a group of systemically important financial institutions. We propose a bank default risk model, in the vein of the classic Merton-type, which utilizes a multi-equation framework to model forward-looking measures of market and credit risk using the credit default swap (CDS) index market as a measure of the global credit environment. In the first step, we establish the existence of significant detrimental volatility spillovers from the CDS market to the banks' equity prices, suggesting a credit shock propagation channel which results in serious deterioration of the valuation of banks' assets. In the second step, we show that substantial capital injections are required to restore the stability of the banking system to an acceptable level after shocks to the CDX and iTraxx indices. Our empirical evidence thus informs the relevant regulatory authorities on the magnitude of banking systemic risk jointly posed by CDS markets

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Published date: 1 July 2010

Identifiers

Local EPrints ID: 193419
URI: http://eprints.soton.ac.uk/id/eprint/193419
PURE UUID: 0fd1b209-af42-43ed-ab93-a0ac8a4e0bb0

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Date deposited: 14 Jul 2011 08:08
Last modified: 18 Jul 2017 11:29

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Contributors

Author: Giovanni Calice
Author: Christos Ioannidis
Author: Julian Williams

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