Financial Stability in European Banking: The Role of Common Factors

Clemens Kool

No 101, Money Macro and Finance (MMF) Research Group Conference 2006 from Money Macro and Finance Research Group

Abstract: In this paper, I investigate the development and determinants of CDS spreads for 18 major European banks between December 2001 and January 2004 using daily data. I demonstrate that two nonstationary common factors can be extracted from the data that together explain most CDS spread variation across time and across banks. The group of German banks plus a few Southern-European banks appear to systematically have high CDS spreads and to be relatively sensitive to changes in the underlying factors. The dominating first common factor impacts on all banks in a similar direction, suggesting strong market integration. However, the quantitatively less important second factor has opposite effects on credit spreads of Southern European versus Northern European banks, suggesting some remaining country-specific or region-specific credit risk. Finally, I show that the first common factor may indeed be interpreted as a measure of market conditions as it is cointegrated with the European P/E ratio and the 2-year nominal interest rate

Keywords: credit default swap spreads; contagion; cointegration; factor analysis (search for similar items in EconPapers)
JEL-codes: G15 G21 G28 (search for similar items in EconPapers)
Date: 2007-02-02
New Economics Papers: this item is included in nep-ban and nep-eec
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Journal Article: Financial Stability in European Banking: The Role of Common Factors (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:mmf:mmfc06:101

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