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The Impact of Credit Default Swaps on Systemic Risk: Macroprudential Solvency and Liquidity Stress Testing

Author

Listed:
  • Walter Farkas

    (University of Zurich - Department Finance; Swiss Finance Institute; ETH Zürich)

  • Fabian Sandmeier

    (University of Zurich - Department of Finance; Swiss Finance Institute)

Abstract

We analyze solvency and liquidity implications of Credit Default Swaps (CDS) in banking networks. We emphasize that one can neither isolate them, nor just analyze them in parallel, but needs to consider their complex interplay. By calibrating our model to the largest banks in the Euro area, we are able to run a large-scale stress test and isolate the effect of different network configurations, as well as different overall coverages of CDS, on systemic risk. An increase in CDS notional always leads to an increase in liquidity risk. The impact on solvency risk is conditional on the topology of the network. We provide a robust network configuration for which an increase in CDS notional leads to a decrease in solvency risk.

Suggested Citation

  • Walter Farkas & Fabian Sandmeier, 2025. "The Impact of Credit Default Swaps on Systemic Risk: Macroprudential Solvency and Liquidity Stress Testing," Swiss Finance Institute Research Paper Series 25-107, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp25107
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    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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