Disentangling the bond-CDS nexus: a stress test model of the CDS market

Tuomas Peltonen () and Guillaume Vuillemey

No 1599, Working Paper Series from European Central Bank

Abstract: This paper presents a stress test model for the CDS market, with a focus on the interplay between banks' bond and CDS holdings. The model enables the analysis of credit risk transfer mechanisms, includes features of market and liquidity risk, and allows for contagious propagation of counterparty failures. As an illustration, we calibrate the model using sovereign bond and CDS data for 65 major European banks. The model simulation shows that, in case of a sovereign credit event, banks' losses due to direct and correlated bond exposures are significantly higher than losses due to CDS exposures. The main risk for CDS sellers is found to be sudden increases in collateral requirements on multiple correlated CDS exposures. Close-out netting considerably reduces the extent to which contagion may occur. JEL Classification: G21, H63, G15

Keywords: collateral; contagion; credit default swap; credit event; liquidity risk; market risk; Stress Test (search for similar items in EconPapers)
Date: 2013-10
New Economics Papers: this item is included in nep-fmk and nep-rmg
Note: 355041
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Journal Article: Disentangling the bond–CDS nexus: A stress test model of the CDS market (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20131599

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