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Unveiling Sovereign Effects in European Banks CDS Spreads Variations

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  • Marc Peters
  • Hugues Pirotte

Abstract

Starting from the structural model developed by Merton (1974) and the derived notion of distance-to-default, we study the determinants of credit default swap (CDS) spreads for a sample of European banks over a period from January 2006 to December 2011. In particular, we test variables that are specific to the banking industry and look at the possible interaction with CDS spreads for the related sovereigns. We confirm findings from the literature review regarding the low significance of the structural model and its breakdown in times of stress. We confirm the importance of macro-economic components such as the general level of interest rates and the general state of the economy, particularly in times of stress. We find that before the crisis period the micro- and macro-components are generally predominant in the determination of CDS spread variations while the influence of sovereigns’ CDS become more important when entering further into the crisis period. Interestingly, southern European countries are the first to become significant at the start of the crisis. Progressively, all CDS countries become increasingly significant, overweigh all other explanatory variables and remain so even after the crisis period, thereby suggesting the focused attention of market participants for the sovereign dimension.

Suggested Citation

  • Marc Peters & Hugues Pirotte, 2014. "Unveiling Sovereign Effects in European Banks CDS Spreads Variations," Working Papers CEB 14-018, ULB -- Universite Libre de Bruxelles.
  • Handle: RePEc:sol:wpaper:2013/174728
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Credit default swaps; CDS spreads; structural model; distance to default; banking debt; sovereign debt;

    JEL classification:

    • 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
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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