Market discipline and too-big-to-fail in the CDS market: Does banks' size reduce market discipline?

Manja Völz and Michael Wedow ()

Journal of Empirical Finance, 2011, vol. 18, issue 2, pages 195-210

Abstract: This paper examines market discipline in the credit default swap (CDS) market and the potential distortion of CDS spreads which arises when a bank is thought to be too-big-to-fail. Overall, we find evidence for market discipline in the CDS market. However, CDS prices are distorted by a size effect when a bank is considered to be too-big-to-fail. A 1 percentage point increase in size reduces the CDS spread of a bank by about 2 basis points. We further find that some banks have already reached a size that makes them too-big-to-be-rescued. While the price distortion for these banks decreases, the existence of banks that are considered to be too-big-to-rescue raises important new issues for banking supervisors.

Keywords: Market; discipline; Too-big-to-fail; Too-big-to-rescue; CDS; spreads (search for similar items in EconPapers)
Date: 2011
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Persistent link: http://EconPapers.repec.org/RePEc:eee:empfin:v:18:y:2011:i:2:p:195-210

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