The Impact of Credit Default Swaps on Systemic Risk: Macroprudential Solvency and Liquidity Stress Testing

Walter Farkas and Fabian Sandmeier
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Walter Farkas: University of Zurich - Department Finance; Swiss Finance Institute; ETH Zürich
Fabian Sandmeier: University of Zurich - Department of Finance; Swiss Finance Institute

No 25-107, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We analyze solvency and liquidity implications of Credit Default Swaps (CDS) in banking networks. We emphasize that one can neither isolate them, nor just analyze them in parallel, but needs to consider their complex interplay. By calibrating our model to the largest banks in the Euro area, we are able to run a large-scale stress test and isolate the effect of different network configurations, as well as different overall coverages of CDS, on systemic risk. An increase in CDS notional always leads to an increase in liquidity risk. The impact on solvency risk is conditional on the topology of the network. We provide a robust network configuration for which an increase in CDS notional leads to a decrease in solvency risk.

Keywords: Systemic Risk; Financial Networks; Credit Default Swaps; Solvency Stress Testing (search for similar items in EconPapers)
JEL-codes: C63 D85 G01 G21 G28 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2025-12
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp25107

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