Analyzing Default Risk and Liquidity Demand during a Financial Crisis: The Case of Canada

Jason Allen, Ali Hortaçsu and Jakub Kastl

Staff Working Papers from Bank of Canada

Abstract: This paper explores the reliability of using prices of credit default swap contracts (CDS) as indicators of default probabilities during the 2007/2008 financial crisis. We use data from the Canadian financial system to show that these publicly available risk measures, while indicative of initial problems of the financial system as a whole, do not seem to correspond to risks implied by the cross-sectional heterogeneity in bank behavior in short-term lending markets. Strategies in, and reliance on the payments system as well as special liquidity-supplying tools provided by the central bank seem to be more important additional indicators of distress of individual banks, or lack thereof than the CDSs. It therefore seems that central banks should utilize high-frequency data on liquidity demand to obtain a better picture of financial health of individual participants of the financial system.

Keywords: Financial Institutions; Financial markets; Payment clearing and settlement systems (search for similar items in EconPapers)
JEL-codes: E42 E58 G01 G28 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2011
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
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Citations: View citations in EconPapers (20)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:11-17

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