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Credit Risk Contagion and the Global Financial Crisis

Author

Listed:
  • Azusa Takeyama

    (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: azusa.takeyama@boj.or.jp))

  • Nick Constantinou

    (Lectuer, Essex Business School, University of Essex (E-mail: nconst@essex.ac.uk))

  • Dmitri Vinogradov

    (Lectuer, Essex Business School, University of Essex (E-mail:dvinog@essex.ac.uk))

Abstract

This paper investigates how the market valuation of credit risk changed during 2008-2009 via a separation of the probability of default (PD) and the loss given default (LGD) of credit default swaps ( CDSs), using the information implied by equity options. While the Lehman Brothers collapse in September 2008 harmed the stability of the financial systems in major industrialized countries, the CDS spreads of some major UK banks did not increase in response to this turmoil in financial markets including the decline in their own stock prices. This implies that the CDS spreads of financial institutions may not reflect all their credit risk due to the government interventions. Since CDS spreads are not appropriate to analyze the impact of the government interventions on credit risk and the cross sectional movement of credit risk, we investigate how the government interventions affect the PD and LGD of financial institutions and how the PD and LGD of financial institutions were related with those of non-financial firms. We demonstrate that the rise in the credit risk of financial institutions did not bring about that of non-financial firms (credit risk contagion) both in the US and UK using principal component analysis.

Suggested Citation

  • Azusa Takeyama & Nick Constantinou & Dmitri Vinogradov, 2012. "Credit Risk Contagion and the Global Financial Crisis," IMES Discussion Paper Series 12-E-15, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:12-e-15
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    References listed on IDEAS

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    More about this item

    Keywords

    Credit Default Swap (CDS); Probability of Default (PD); Loss Given Default (LGD); Credit Risk Contagion;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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