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What determines Euro area bank CDS spreads?

Jan Annaert, Marc De Ceuster, Patrick Van Roy () and Cristina Vespro

Journal of International Money and Finance, 2013, vol. 32, issue C, 444-461

Abstract: This paper decomposes the explained part of the CDS spread changes of 32 listed euro area banks according to various risk drivers. The choice of the credit risk drivers is inspired by the Merton (1974) model. Individual CDS liquidity and other market and business variables are identified to complement the Merton model and are shown to play an important role in explaining credit spread changes. Our decomposition reveals, however, highly changing dynamics in the credit, liquidity, and business cycle and market wide components. This result is important since supervisors and monetary policy makers extract different signals from liquidity based CDS spread changes than from business cycle or credit risk based changes. For the recent financial crisis, we confirm that the steeply rising CDS spreads are due to increased credit risk. However, individual CDS liquidity and market wide liquidity premia played a dominant role. In the period before the start of the crisis, our model and its decomposition suggest that credit risk was not correctly priced, a finding that was correctly observed by e.g. the International Monetary Fund.

Keywords: CDS spreads; Banks; Crisis; Liquidity (search for similar items in EconPapers)
JEL-codes: G01 G13 G21 (search for similar items in EconPapers)
Date: 2013
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Related works:
Working Paper: What determines euro area bank CDS spreads ? (2010) Downloads
Journal Article: What determines euro area bank CDS spreads ? (2009) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:32:y:2013:i:c:p:444-461

DOI: 10.1016/j.jimonfin.2012.05.029

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