Firm and Guarantor Risk, Risk Contagion, and the Interfirm Spread among Insured Deposits

Douglas O. Cook and Lewis J. Spellman

Journal of Financial and Quantitative Analysis, 1996, vol. 31, issue 2, 265-281

Abstract: We develop a model of third party guaranteed debt and show that interest rate premiums are multiplicatively related to firm and guarantor risk. We apply the model to thrifts issuing CDs guaranteed by the FSLIC and then estimate firm probabilities of insolvency and guarantor risk across 20 observed months. This time period spans the insolvency of the guarantor followed by two recapitalizations. The relative stability in firm risk across time offers no evidence of generalized risk contagion among firms. We attribute elevated CD premiums and rate spreads to increases in guarantor risk rather than changes in firm risk.

Date: 1996
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