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Looking through systemic credit risk: determinants, stress testing and market value

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  • Álvaro Chamizo

    (BBVA.)

  • Alfonso Novales

    (Instituto Complutense de Análisis Económico (ICAE), and Department of Economic Analysis, Facultad de Ciencias Económicas y Empresariales, Universidad Complutense, 28223 Madrid, Spain.)

Abstract

We provide a methodology to estimate a Global Credit Risk Factor (GCRF) from CDS spreads using the information provided by the default-related component of observed spreads. These are previ- ously estimated using Pan and Singleton (2008) methodology. The estimated factor contains higher explanatory power on CDS spread fluctuations across sectors than standard credit indices like iTraxx or CDX. We find a positive association between GCRF and implied volatility variables, and a negative association with MSCI stock market sector indices as well as with interest rates and with the slope and the curvature of the term structure. Such correlations provide useful insights for risk management as well as for the hedging of credit portfolios. Indeed, we present a synthetic factor regression model for GCRF that we apply in a stress testing methodology for credit portfolios as well as to evaluate future credit risk scenarios. Finally, we show evidence suggesting that the exposure to systemic credit risk was priced in the market during the 2006-2015 period.

Suggested Citation

  • Álvaro Chamizo & Alfonso Novales, 2019. "Looking through systemic credit risk: determinants, stress testing and market value," Documentos de Trabajo del ICAE 2019-27, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    • Handle: RePEc:ucm:doicae:1927
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    Cited by:

    1. Chamizo, Álvaro & Novales, Alfonso, 2021. "Evaluation of market risk associated with hedging a credit derivative portfolio," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 411-430.
    2. Ballester, Laura & López, Jesúa & Pavía, Jose M., 2023. "European systemic credit risk transmission using Bayesian networks," Research in International Business and Finance, Elsevier, vol. 65(C).
    3. Caiazza, Stefano & Galloppo, Giuseppe & La Rosa, Giovanni, 2023. "The mitigation role of corporate sustainability: Evidence from the CDS spread," Finance Research Letters, Elsevier, vol. 52(C).

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    More about this item

    Keywords

    Credit Risk; Systemic Risk; Idiosyncratic Risk; Stress Tests; Factor Models; Market Pricing.;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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