Credit Default Swaps as Indicators of Bank financial Distress

We examine whether CDS contracts written on individual banks are effective leading indicators of bank financial distress during a period of systemic bank crisis. Changes in CDS spreads are found to yield a robust signal of failure across a set of European and US banks, in keeping with indirect market discipline. Furthermore, changes in CDS spreads provide information about the condition of banks which supplements that available from equity markets and contained in accounting metrics. Consistent results are detailed for both senior and subordinated CDS spreads. Our results hold out-of-sample, for logit and proportional hazards models, for various cohorts, for idiosyncratic changes in CDS and are robust to the use of alternative measures of bank distress, including rating downgrades and accounting risk.