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The Credit Risk Transfer Market and Stability Implications for U.K. Financial Institutions

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Author Info

  • Li L. Ong
  • Jorge A. Chan-Lau

Abstract

The increasing ability to trade credit risk in financial markets has facilitated its dispersion across the financial and other sectors. However, specific risks attached to credit risk transfer (CRT) instruments in a market with still-limited liquidity means that its rapid expansion may actually pose problems for financial sector stability in the event of a major negative shock to credit markets. This paper attempts to quantify the exposure of major U.K. financial groups to credit derivatives, by applying a vector autoregression (VAR) model to publicly available market prices. Our results indicate that use of credit derivatives does not pose a substantial threat to financial sector stability in the United Kingdom. Exposures across major financial institutions appear sufficiently diversified to limit the impact of any shock to the market, while major insurance companies are largely exposed to the "safer" senior tranches.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/139.

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Length: 27
Date of creation: 01 Jun 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/139

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Related research

Keywords: Financial stability; credit derivatives; credit risk; hedge; financial institutions; risk transfer; derivatives market; insurance companies; financial sector; bonds; hedge funds; bond; life insurers; derivative; hedging; credit derivative; basis risk; arbitrage; financial markets; life insurance; financial instruments; risk management; pension funds; attachment point; corporate bonds; derivatives markets; financial statements; stock trades; hedges; derivatives instruments; financial system; financial services; market risk; financial systems; financial reporting; government bonds; banks in insurance; derivative security; derivative instrument; stock price; accounting standards; insurance supervisors; liquid liabilities; hedge accounting; bond defaults; underwriting; insurable risks; equity shares; cash flow; corporate bond market; risk of loss; financial sector performance; bond market; perfect hedges; credit risk exposure; credit insurance; financial assets; credit ratings; hedging instruments; risk transfer instruments; securities markets; cash flows; holders of bonds; derivative markets; bond default; reinsurance; risk profile; financial market; corporate bond; treasury bonds; capital requirements; financial instability; international bond;

References

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  1. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
  2. Ingo Fender & John Kiff, 2004. "CDO rating methodology: Some thoughts on model risk and its implications," BIS Working Papers 163, Bank for International Settlements.
  3. Cousseran, O. & Rahmouni, I., 2005. "The CDO market Functioning and implications in terms of financial stability," Financial Stability Review, Banque de France, issue 6, pages 43-62, June.
  4. Marsh, Ian W & Wagner, Wolf, 2004. "Credit Risk Transfer and Financial Sector Performance," CEPR Discussion Papers 4265, C.E.P.R. Discussion Papers.
  5. Michael S. Gibson, 2004. "Understanding the risk of synthetic CDOs," Finance and Economics Discussion Series 2004-36, Board of Governors of the Federal Reserve System (U.S.).
  6. Marco Stringa & Allan Monks, 2007. "Inter-industry contagion between UK life insurers and UK banks: an event study," Bank of England working papers 325, Bank of England.
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Cited by:
  1. Mork├Âtter, Stefan & Westerfeld, Simone, 2009. "Rating model arbitrage in CDO markets: An empirical analysis," International Review of Financial Analysis, Elsevier, vol. 18(1-2), pages 21-33, March.

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