The Market-implied Probability of European Government Intervention in Distressed Banks

Richard Neuberg (), Paul Glasserman (), Benjamin Kay () and Sriram Rajan ()
Additional contact information
Richard Neuberg: Columbia University
Paul Glasserman: Columbia University
Benjamin Kay: Office of Financial Research
Sriram Rajan: Office of Financial Research

No 16-10, Working Papers from Office of Financial Research, US Department of the Treasury

Abstract: New contract terms for credit default swaps (CDS) on banks were introduced in 2014 to cover losses from government intervention and related bail-in events. For many large European banks, CDS spreads are available under both the old and new contract terms; the difference (or basis) between the two spreads measures the market price of protection against losses from certain government actions to resolve distressed banks. We investigate cross-sectional and time series properties of this basis, relative to each bank's CDS spread. We interpret a general decline in the relative basis as a market price-based signal that governments are less likely to bailout banks in distress, but that banks do not yet have sufficient bail-in debt to protect senior bond holders in case of a credit event.

Keywords: Credit default swaps; banks; government intervention; European Bank Resolution and Recovery Directive (search for similar items in EconPapers)
Pages: 43 pages
Date: 2016-10-11
New Economics Papers: this item is included in nep-ban
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Citations: View citations in EconPapers (5)

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