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Contagion and Risk in the Amplification of Crisis : Evidence from Asian Names in the CDS Market

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Author Info

  • Don H. Kim

    (Yonsei University and Bank for International Settlements)

  • Mico Loretan
  • Eli M. Remolona

Abstract

In the turmoil of 20072009, troubles in a relatively small corner of the US mortgage market escalated into a crisis of global proportions. An amplification mechanism were the huge valuation losses on credit instruments, which dwarfed actual losses from default. We argue that these valuation losses were driven not so much by a reassessment of risks as by a global repricing of these risks. For empirical evidence, we analyze fluctuations in credit default swap (CDS) spreads and expected default frequencies (EDFs) for major Asian borrowers. Because EDFs are estimated to exploit the forward-looking nature of stock prices, their use allows us to account for knock-on effects from the slowing economy on default risk. We find that valuation losses on CDS contracts for these borrowers arose in large part from movements in global and regional risk pricing factors rather than from revisions in individual expected losses from default alone.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series EABER Working Papers with number 22861.

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Date of creation: Jan 2009
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Handle: RePEc:eab:wpaper:22861

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Postal: JG Crawford Building #13, Asia Pacific School of Economics and Government, Australian National University, ACT 0200
Web page: http://www.eaber.org
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Related research

Keywords: sub-prime; mortgage crisis; turmoil; meltdown; amplification; valuation; credit default swap; expected default frequency; risk premia; credit bubble;

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References

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  1. Gengenbach,Christian & Palm,Franz C. & Urbain,Jean-Pierre, 2005. "Panel Cointegration Testing in the Presence of Common Factors," Research Memorandum 050, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  2. Bai, Jushan & Kao, Chihwa & Ng, Serena, 2009. "Panel cointegration with global stochastic trends," Journal of Econometrics, Elsevier, vol. 149(1), pages 82-99, April.
  3. Peter C.B. Phillips, 1985. "Understanding Spurious Regressions in Econometrics," Cowles Foundation Discussion Papers 757, Cowles Foundation for Research in Economics, Yale University.
  4. Joost Driessen, 2005. "Is Default Event Risk Priced in Corporate Bonds?," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 165-195.
  5. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
  6. Breitung, J rg & Das, Samarjit, 2008. "Testing For Unit Roots In Panels With A Factor Structure," Econometric Theory, Cambridge University Press, vol. 24(01), pages 88-108, February.
  7. Pedroni, Peter, 2004. "Panel Cointegration: Asymptotic And Finite Sample Properties Of Pooled Time Series Tests With An Application To The Ppp Hypothesis," Econometric Theory, Cambridge University Press, vol. 20(03), pages 597-625, June.
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Cited by:
  1. Xin Huang & Hao Zhou & Haibin Zhu, 2009. "Assessing the systemic risk of a heterogeneous portfolio of banks during the recent financial crisis," Finance and Economics Discussion Series 2009-44, Board of Governors of the Federal Reserve System (U.S.).

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