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Tail dependence of financial stocks and CDS markets: Evidence using copula methods and simulation-based inference


  • da Silva, Paulo Pereira
  • Rebelo, Paulo Tomaz
  • Afonso, Cristina


Using copula methods and simulation-based inference the authors address the association between the performance of the stocks of European banks and the CDS markets. Their analysis has three purposes: (i) analysing the dependence structure of the markets when extreme events occur; (ii) checking the validity of the conclusion of Merton (On the Pricing of Corporate Debt: The Risk Structure of Interest Rates, 1974) and other similar structural models concerning the intensification of the relationship between stock prices and credit spreads during financial distress periods; (iii) analysing the auto-covariance of the dependence structure. First, the results show symmetric dependence and tail dependency equality between the two markets. This means that, surprisingly, the association between stock prices and spreads of the banking sector does not seem to surge in financial distress periods, contradicting the conclusions of Merton (1974) and other structural models, which could be related with a too-big-to-fail effect. Second, the authors do not detect structural breaks in the dependence structure in a period marked by the U.S. financial crisis (2008) and the European sovereign debt crisis (2010), which posed concerns on the European financial system health. Finally, they find evidence that the dependence between the markets is autoregressive and possibly time variant. The authors suggest that the inexistence of a higher negative tail dependence between the filtered returns may reside in the too-big-to fail effect, that is, credit holders receive a subsidy from governments protecting them from bankruptcy costs, contrary to what happens with equity holders whose capital is wiped-out if the bank fails.

Suggested Citation

  • da Silva, Paulo Pereira & Rebelo, Paulo Tomaz & Afonso, Cristina, 2013. "Tail dependence of financial stocks and CDS markets: Evidence using copula methods and simulation-based inference," Economics Discussion Papers 2013-52, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwedp:201352

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    References listed on IDEAS

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    Cited by:

    1. Yoshiko Suzuki, 2016. "European banks' funding realignment during the European debt crisis: impact of counterparty risk and funding liquidity on FX swap pricing," Economics Bulletin, AccessEcon, vol. 36(2), pages 696-703.
    2. Atil, Ahmed & Bradford, Marc & Elmarzougui, Abdelaziz & Lahiani, Amine, 2016. "Conditional dependence of US and EU sovereign CDS: A time-varying copula-based estimation," Finance Research Letters, Elsevier, vol. 19(C), pages 42-53.
    3. Bouri, Elie & de Boyrie, Maria E. & Pavlova, Ivelina, 2017. "Volatility transmission from commodity markets to sovereign CDS spreads in emerging and frontier countries," International Review of Financial Analysis, Elsevier, vol. 49(C), pages 155-165.
    4. repec:eee:intfin:v:52:y:2018:i:c:p:114-133 is not listed on IDEAS
    5. Zhu, Huiming & Huang, Hui & Peng, Cheng & Yang, Yan, 2016. "Extreme dependence between crude oil and stock markets in Asia-Pacific regions: Evidence from quantile regression," Economics Discussion Papers 2016-46, Kiel Institute for the World Economy (IfW).

    More about this item


    CDS markets; credit risk; contagion; Merton's model; copulas; simulation based inference; banking;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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