The Role of Redenomination Risk in the Price Evolution of Italian Banks’ CDS Spreads

Michele Anelli, Michele Patanè, Mario Toscano and Stefano Zedda
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Michele Anelli: Department of Economics and Statistics, School of Economics and Management, University of Siena, 53100 Siena, Italy
Michele Patanè: Department of Business and Law, School of Economics and Management, University of Siena, 53100 Siena, Italy
Mario Toscano: Department of Business and Law, School of Economics and Management, University of Siena, 53100 Siena, Italy
Stefano Zedda: Department of Business and Economics, University of Cagliari, 09123 Cagliari, Italy

JRFM, 2020, vol. 13, issue 7, 1-17

Abstract: The recent financial crisis offered an interesting opportunity to analyze the markets’ behavior in a high-volatility framework. In this paper, we analyzed the price discovery process of the Italian banks’ Credit Default Swap (CDS) spreads through the Merton model, extended with the inclusion of a redenomination risk proxy, as to say, the risk that Italy could leave the eurozone. This paper contributes to the literature by integrating the classic Merton model with a political-sensitive market variable able to explain the greatest variance in the Italian banks’ CDS spreads during the most relevant and commonly recognized periods of socio-political and financial distress. Results show that the redenomination risk is progressively becoming the main driver of the process during crises, in particular for the sovereign debt crisis and in 2018.

Keywords: CDS spreads; redenomination risk; quanto CDS; Granger-causality (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2020
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