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Contagion and Risk in the Amplification of Crisis : Evidence from Asian Names in the CDS Market

Author

Listed:
  • Don H. Kim

    (Yonsei University and Bank for International Settlements)

  • Mico Loretan
  • Eli M. Remolona

Abstract

In the turmoil of 20072009, troubles in a relatively small corner of the US mortgage market escalated into a crisis of global proportions. An amplification mechanism were the huge valuation losses on credit instruments, which dwarfed actual losses from default. We argue that these valuation losses were driven not so much by a reassessment of risks as by a global repricing of these risks. For empirical evidence, we analyze fluctuations in credit default swap (CDS) spreads and expected default frequencies (EDFs) for major Asian borrowers. Because EDFs are estimated to exploit the forward-looking nature of stock prices, their use allows us to account for knock-on effects from the slowing economy on default risk. We find that valuation losses on CDS contracts for these borrowers arose in large part from movements in global and regional risk pricing factors rather than from revisions in individual expected losses from default alone.

Suggested Citation

  • Don H. Kim & Mico Loretan & Eli M. Remolona, 2009. "Contagion and Risk in the Amplification of Crisis : Evidence from Asian Names in the CDS Market," EABER Working Papers 22861, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:wpaper:22861
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    File URL: http://www.eaber.org/node/22861
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    References listed on IDEAS

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    1. Bai, Jushan & Kao, Chihwa & Ng, Serena, 2009. "Panel cointegration with global stochastic trends," Journal of Econometrics, Elsevier, vol. 149(1), pages 82-99, April.
    2. Pedroni, Peter, 2004. "Panel Cointegration: Asymptotic And Finite Sample Properties Of Pooled Time Series Tests With An Application To The Ppp Hypothesis," Econometric Theory, Cambridge University Press, vol. 20(03), pages 597-625, June.
    3. Joost Driessen, 2005. "Is Default Event Risk Priced in Corporate Bonds?," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 165-195.
    4. Phillips, P.C.B., 1986. "Understanding spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 33(3), pages 311-340, December.
    5. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
    6. Breitung, J rg & Das, Samarjit, 2008. "Testing For Unit Roots In Panels With A Factor Structure," Econometric Theory, Cambridge University Press, vol. 24(01), pages 88-108, February.
    7. Gengenbach Christian & Palm Franz C. & Urbain Jean-Pierre, 2005. "Panel Cointegration Testing in the Presence of Common Factors," Research Memorandum 050, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
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    Cited by:

    1. Huang, Xin & Zhou, Hao & Zhu, Haibin, 2012. "Assessing the systemic risk of a heterogeneous portfolio of banks during the recent financial crisis," Journal of Financial Stability, Elsevier, vol. 8(3), pages 193-205.

    More about this item

    Keywords

    sub-prime; mortgage crisis; turmoil; meltdown; amplification; valuation; credit default swap; expected default frequency; risk premia; credit bubble;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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