Do banks’ overnight borrowing rates lead their CDS price? Evidence from the Eurosystem

Eero Tölö, Esa Jokivuolle () and Matti Virén

Journal of Financial Intermediation, 2017, vol. 31, issue C, 93-106

Abstract: We construct a measure of a bank's relative creditworthiness from the Eurosystem's proprietary inter-bank loan data: average overnight borrowing rate relative to an overnight rate index (AOR). We then investigate the dynamic relationship between AOR and the credit default swap price relative to the corresponding market index of 60 banks during 2008–2013. Price discovery mainly takes place in the CDS market, but AOR also contributes to it. The lagged daily changes of AOR help predict CDS. This indicates that AOR includes private information, which the CDS market does not immediately incorporate. We further show that the private information advantage is concentrated on days of market stress and on banks, which mainly borrow from relationship lender banks. Such borrower banks are typically smaller, have weaker ratings, and are likely to reside in crisis countries. Competent authorities can use AOR as a complementary indicator of banks’ concurrent health.

Keywords: Private information; Money markets; Overnight borrowing rates; Credit default swaps (CDS); Lead-lag relationship; TARGET2; Eurosystem; Early-warning indicators (search for similar items in EconPapers)
JEL-codes: G01 G14 G21 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Working Paper: Do banks’ overnight borrowing rates lead their CDS Price? Evidence from the Eurosystem (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:31:y:2017:i:c:p:93-106

DOI: 10.1016/j.jfi.2017.05.006

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