What determines euro area bank CDS spreads ?
AbstractThis paper decomposes the explained part of the CDS spread changes of 31 listed euro area banks according to various risk drivers. The choice of the credit risk drivers is inspired by the Merton (1974) model. Individual CDS liquidity and other market and business variables are identified to complement the Merton model and are shown to play an important role in explaining credit spread changes. Our decomposition reveals, however, highly changing dynamics in the credit, liquidity, and business cycle and market wide components. This result is important since supervisors and monetary policy makers extract different signals from liquidity based CDS spread changes than from business cycle or credit risk based changes. For the recent financial crisis, we confirm that the steeply rising CDS spreads are due to increased credit risk. However, individual CDS liquidity and market wide liquidity premia played a dominant role. In the period before the start of the crisis, our model and its decomposition suggest that credit risk was not correctly priced, a finding which was correctly observed by e.g. the International Monetary Fund
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Bibliographic InfoPaper provided by National Bank of Belgium in its series Working Paper Research with number 190.
Length: 38 pages
Date of creation: May 2010
Date of revision:
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credit default spreads; credit risk; financial crisis; financial sector; liquidity premia; structural model;
Other versions of this item:
- Annaert, Jan & De Ceuster, Marc & Van Roy, Patrick & Vespro, Cristina, 2013. "What determines Euro area bank CDS spreads?," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 444-461.
- Jan Annaert & Marc De Ceuster & Patrick Van Roy & Cristina Vespro, 2009. "What determines euro area bank CDS spreads ?," Financial Stability Review, National Bank of Belgium, vol. 7(1), pages 153-169, June.
- G01 - Financial Economics - - General - - - Financial Crises
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-05-15 (All new papers)
- NEP-BAN-2010-05-15 (Banking)
- NEP-BEC-2010-05-15 (Business Economics)
- NEP-CBA-2010-05-15 (Central Banking)
- NEP-EEC-2010-05-15 (European Economics)
- NEP-RMG-2010-05-15 (Risk Management)
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- International Monetary Fund, 2012. "Are Rating Agencies Powerful? An Investigation into the Impact and Accuracy of Sovereign Ratings," IMF Working Papers 12/23, International Monetary Fund.
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