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Credit default swap spreads and systemic financial risk

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  • Giglio, Stefano

Abstract

This paper measures the joint default risk of financial institutions by exploiting information about counterparty risk in credit default swaps (CDS). A CDS contract written by a bank to insure against the default of another bank is exposed to the risk that both banks default. From CDS spreads we can then learn about the joint default risk of pairs of banks. From bond prices we can learn the individual default probabilities. Since knowing individual and pairwise probabilities is not sufficient to fully characterize multiple default risk, I derive the tightest bounds on the probability that many banks fail simultaneously. JEL Classification: G28, G21, E44

Suggested Citation

  • Giglio, Stefano, 2016. "Credit default swap spreads and systemic financial risk," ESRB Working Paper Series 15, European Systemic Risk Board.
    • Handle: RePEc:srk:srkwps:201615
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    File URL: https://www.esrb.europa.eu//pub/pdf/wp/esrbwp15.en.pdf
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    References listed on IDEAS

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    1. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
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    More about this item

    Keywords

    counterparty risk; credit default swaps; default risk; simultaneous failures;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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