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Liquidation equilibrium with seniority and hidden CDO

Author

Listed:
  • Gourieroux, C.
  • Heam, J.C.
  • Monfort, A.

Abstract

The aim of our paper is to price credit derivatives written on a single name when this name is a bank. Indeed, due to the special structure of the balance sheet of a bank and to the interconnections with other institutions of the financial system, the standard pricing formulas do not apply and their use can imply severe mispricing. The pricing of credit derivatives written on a single bank name requires a joint analysis of the risks of all banks directly or indirectly interconnected with the bank of interest. Each name cannot be priced in isolation, but the banking system must be treated as a whole. It is necessary to analyze the contagion of losses among banks, especially the equilibrium of joint defaults and recovery rates at liquidation time. We show the existence and uniqueness of such an equilibrium. Then the standard pricing formulas are modified by adding a premium to capture the contagion effects.

Suggested Citation

  • Gourieroux, C. & Heam, J.C. & Monfort, A., 2013. "Liquidation equilibrium with seniority and hidden CDO," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5261-5274.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:12:p:5261-5274
    DOI: 10.1016/j.jbankfin.2013.04.016
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    References listed on IDEAS

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    1. Demange, Gabrielle, 2012. "Contagion in financial networks: A threat index," CEPR Discussion Papers 8793, C.E.P.R. Discussion Papers.
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    Cited by:

    1. Fourel, V. & Héam, J-C. & Salakhova, D. & Tavolaro, S., 2013. "Domino Effects when Banks Hoard Liquidity: The French network," Working papers 432, Banque de France.
    2. Johannes Hain & Tom Fischer, 2015. "Valuation Algorithms for Structural Models of Financial Interconnectedness," Papers 1501.07402, arXiv.org.
    3. Paul Glasserman, 2015. "Contagion in Financial Networks," Economics Series Working Papers 764, University of Oxford, Department of Economics.
    4. Jean-Cyprien H'eam & Erwan Koch, 2014. "Diversification and Endogenous Financial Networks," Papers 1408.4618, arXiv.org, revised Feb 2015.
    5. Jose Fique, 2017. "Retrieving Implied Financial Networks from Bank Balance-Sheet and Market Data," Staff Working Papers 17-30, Bank of Canada.
    6. Ivan Alves & Stijn Ferrari & Pietro Franchini & Jean-Cyprien Heam & Pavol Jurca & Sam Langfield & Sebastiano Laviola & Franka Liedorp & Antonio Sánchez & Santiago Tavolaro & Guillaume Vuillemey, 2013. "The structure and resilience of the European interbank market," ESRB Occasional Paper Series 03, European Systemic Risk Board.
    7. Paul Glasserman & H. Peyton Young, 2016. "Contagion in Financial Networks," Journal of Economic Literature, American Economic Association, vol. 54(3), pages 779-831, September.

    More about this item

    Keywords

    Collateralized debt obligation; Contagion; Solvency risk; Value-of-the firm model; Liquidation equilibrium; Contagion premium; Systemic risk;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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