Relationships between Financial Sectors’ CDS Spreads and Other Gauges of Risk: Did the Great Recession Change Them? (original) (raw)
The effects of 2007-2008 crisis on the CDS and the interbank markets: Empirical investigations
2013
The global crisis of 2007-2008 is the most severe crisis since the Great Depression in the financial markets. Starting with the subprime defaults in the United States, it quickly spills over into other markets leading to the collapses of many financial institutions, bail-outs of banks worldwide and downturns in asset prices. The aim of this thesis is to investigate the repercussions of this crisis on CDS and interbank market and provide empirical evidence on the changes in the pricing of CDS contracts and interbank deposits. Chapter 2 discusses the determinants of CDS spread changes on European contracts. The most remarkable finding of the study is that the relation between credit spreads and their determinants is regime dependant and depends on the sector of economic activity. Before the crisis the underlying credit risk in the overall CDS market is sufficient to explain credit risk. During the crisis investors have a differing view on the risk of financial and non--financial contr...
SSRN Electronic Journal, 2010
Extending Longstaff's (2010) approach, this study uses the pre-, occurrence and persistentperiods of sub-prime crises in order to examine changes in global impulse responses, variance decompositions and contagion effects from the direct indices (i.e., ABX indices) of collateralised debt obligation (CDO), one kind of risky asset-backed securities (ABS), to the indices of credit default swaps (CDS). We then examine the similar approaches from CDS indices to associated bond indices. This paper is the first study to analyse the effects of shocks of financial crises on global bond markets through financial markets of risky ABS and CDS, simultaneously. These approaches are valuable because an investor buying a risky ABS tends to purchase a CDS to hedge the risks of the ABS, which then this CDS will transmit credit risks to capital markets. Our findings show significant impulse responses and contagion effects from lower-rated ABX index returns to associated CDS index returns, as opposed to higher-rated ABX index returns after a crisis occurs. During the outbreak of a crisis, a sharp increase in impulse responses from CDS index returns to bond index returns in emerging markets has been observed, as well as a larger rise in the variance ratio from CDS indices to Asian and Non-Asian emerging market bond indices, as opposed to developed market bond indices. Thus,
HOW DID CDS MARKETS IMPACT STOCK MARKETS? EVIDENCE FROM LATEST FINANCIAL CRISIS
It is well-documented that financial markets become more integrated during turmoil periods. In addition, the recent global financial crisis has led to an in depth analysis and discussion of the pros and cons of derivative instruments, particularly credit default swaps, which are considered as the best proxy for firm and sovereign default risk. The aim of this study is to explore if default risk, represented by CDS spreads, is embedded in stock returns. Our main assertion rests on the idea that if CDS spreads proxy default risk, then it should have informational content for stock markets and should have a significant impact in price formation process. The analysis is conducted by using CDS Regional Index spreads and MSCI Regional Index values in Europe, Pacific Region and Emerging Markets. The results indicate that changes in CDS Regional Index spreads significantly impact stock indices within the same region as well as cross-regionally.
Linkages between Financial Sector CDS Spreads and Macroeconomic Influence in a Nonlinear Setting
Research Papers in Economics, 2014
This paper investigates the asymmetric and nonlinear transmission of financial and energy prices to US five-year financial CDS sector index spreads for the banking, financial services and insurance sectors in the short-and long-run over the recent periods revolving around the global financial crisis. We employ the nonlinear ARDL (NARDL) model to account for the short-and long-run asymmetries in the sensitivity of those CDS sector index spreads to their determinants. Our findings suggest that there is evidence of short-and long-run nonlinearities and asymmetries in the adjustment process of the three CDS variables. There are also shortand long-run asymmetries in the influences of macroeconomic and financial variables on the CDS sector spreads. These findings are important for policymakers who deal with credit risks at the sector levels.JEL Codes: C32, F65, G01
Journal of Risk and Financial Management, 2019
This study examines the impact of changes in the yield curve factors on the Credit Default Swap (CDS) spreads of the U.S. industrial sectors. Stock returns and the crude oil-based volatility index are used in a quantile regression framework to test the validity of Merton’s model. The results suggest that the long-term factor of the yield curve is a negatively significant determinant of the CDS premia regardless of the sector and market state. The CDS spread of the financial sector exhibits sensitivity to the short-term factor of the yield rate in extreme market states. Basic materials, oil and gas and the utilities sector are responsive to variations in the medium-term factor of the yield rate in upmarket conditions. The empirical findings also suggest a significant inverse relationship between CDS spreads and stock returns.
This paper examines the determinants of CDS spreads and potential spillover effects for Eurozone countries during the recent financial crisis in the EU. We employ a Panel Vector Autoregressive (PVAR) model which combines the advantages of traditional VAR modelling with the advantages of a panel-data approach. In addition to variables that proxy for global and financial market spread determinants we also employ variables that proxy for behavioral determinants. We find that the determinants of CDS variance are neither uniform nor stable during different periods and different countries. For instance, as we move from 2008 to 2014 the impact of the slope of the term structure on CDS spread variance is increasing for Spain, Portugal, Italy, Greece, Ireland, and decreasing for Germany, France, Netherlands, Belgium and Austria. Other findings indicate that investor sentiment may be an important CDS spread determinant during the period between 2008 and 2010, along with other factors, while spillover effects may run from Spain and Italy to core countries while spillover effects from Portugal, Greece, and Ireland are of minor importance.
Systematic and Idiosyncratic Risks of Changes in CDS Spreads
2015
Using a sample of 356 U.S. non-financial firms from 2002 to 2011, we derive endogenous systematic credit risk and Credit Default Swap (CDS) illiquidity factors, and show that they dominate firm-specific and exogenous market factors as determinants of individual firms' CDS spreads. Our model performs well for cross-sectional predictions and can be used for estimating CDS spreads for firms that do not have traded CDSs. Our findings question Basel III's adoption of CDS-implied probability for counterparty risk management, as CDS spread is not a pure individual firm default risk measure devoid of market credit and illiquidity premia.
Financial CDS, stock market and interest rates: Which drives which?
The North American Journal of Economics and Finance, 2011
The objective is to examine the short-and long-run dynamics of US financial CDS index spreads at the sector level and explore their relationships with the stock market and the short-and long-run government securities, paying particular attention to the subperiod that begins with the 2007 Great Recession. We use daily time series for the three US five-year CDS index spreads for banking, financial services and insurance sectors, the S&P 500 index, the short-and long-term Treasury securities rates. Employing the Autoregressive Distributed Lag approach (ARDL), this study finds more long-run relationships between the five financial variables in Model II that includes the six-month T bill rate than Model I that includes the 10-year T bond rate. The long-run relationships have weakened in both models under the subperiod than the full period. Moreover, the short-run dynamics have changed under the subperiod but the changes are mixed. Implications are relevant for decision-makers who are interested in financial relationships at the sector level than at the firm level.
CDS Spreads: An Empirical Analysis of European Countries
2015
This thesis investigates how credit default risk as reflected in credit default swap (CDS) spread is transferred in the European countries. The first part observes the default risk transfer between the sovereign debt and the domestic financial institutions of the European countries during the European sovereign debt crisis. The previous literature indicates that a "two-way feedback" effect exists between the two sectors. In this part, the bailouts by the European Financial Stability Facility are used as breakpoints to examine the changes in the default risk transfer between the two sectors. The results suggest that the two-way feedback effect does not exist after the first Greek bailout. The shocks in the financial sector transmitting to the sovereign debts become either negative or insignificant in both the short and the long runs. Subsequent to the first Greek bailout, the private-to-public risk transfer no longer exerts significant impacts, regardless of later bailouts issued to the other countries. The second part further examines the structural regimes in the cointegration relationship of default risk between the two sectors. The empirical results indicate that the private-to-public risk transfer becomes stronger in the 'atypical' regimes, which covers the crisis periods. The approach of identifying changes in regime is robust, and the detected thresholds also confirm that it is reasonable using the EFSF bailout events as breakpoints. The final empirical chapter focuses on the crosscountry cointegration of sovereign default risk, and takes note of the role of investor sentiment in explaining the risk transfer. The findings show that investor sentiment is capable to predict regimes in the sovereign default risk in the short run. During crisis periods, the trench of the sovereign default risk is wider, but the elasticity is smaller, indicating more difficulties for the countries to close the gap of the default risk.
This paper analyzes counterparty exposures in the credit default swaps market and examines the impact of severe credit shocks on the demand for variation margin, which are the payments that counterparties make to offset price changes. We employ the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) shocks and estimate their impact on the value of CDS contracts and the variation margin owed. Large and sudden demands for variation margin may exceed a firm's ability to pay, leading some firms to delay or forego payments. These shortfalls can become amplified through the network of exposures. Of particular importance in cleared markets is the potential impact on the central counterparty clearing house. Although a central node according to conventional measures of network centrality, the CCP contributes less to contagion than do several peripheral firms that are large net sellers of CDS protection. During a credit shock these firms can suffer large shortfalls that lead to further shortfalls for their counterparties, amplifying the initial shock.
Unveiling Sovereign Effects in European Banks CDS Spreads Variations
SSRN Electronic Journal, 2000
Starting from the structural model developed by and the derived notion of distanceto-default, we study the determinants of credit default swap (CDS) spreads for a sample of European banks over a period from January 2006 to December 2011. In particular, we test variables that are specific to the banking industry and look at the possible interaction with CDS spreads for the related sovereigns. We confirm findings from the literature review regarding the low significance of the structural model and its breakdown in times of stress. We confirm the importance of macro-economic components such as the general level of interest rates and the general state of the economy, particularly in times of stress. We find that before the crisis period the micro-and macro-components are generally predominant in the determination of CDS spread variations while the influence of sovereigns' CDS become more important when entering further into the crisis period. Interestingly, southern European countries are the first to become significant at the start of the crisis. Progressively, all CDS countries become increasingly significant, overweigh all other explanatory variables and remain so even after the crisis period, thereby suggesting the focused attention of market participants for the sovereign dimension.
2009
This paper investigates potential contagion among the major financial institutions in developed economies. Using Credit Default Swaps (CDS) premia as a measure of credit or counterparty risk, our analysis focuses on the extreme co-movements of Financial Institutions' default contracts during the high level of stress undergone by the CDS markets in the aftermath of the 2007 sub-prime crisis. Our approach is twofold: first, under different tail dependence scenarios, we calibrate several multivariate linear propagation models of constant correlation. Our Monte Carlo simulation study finds evidence of contagion for Financial Institutions-notably in the US-and captures a non-normal dependence structure in the tails for the traded contracts. Second, we estimate a multivariate Dynamic Conditional Correlation-GARCH (DCC-GARCH) model, and demonstrate significant ARCH and GARCH effects, as well as time-varying correlations in CDS spreads variations. Our overall analysis rejects the assumption of constant correlation. More importantly, it advocates changing structures in tail dependence for CDS series during times of financial turmoil as an important feature of banks" increased fragility. +33
Impacts of the financial crisis on eurozone sovereign CDS spreads
Journal of International Money and Finance, 2014
We study the variation of sovereign credit default swaps (CDSs) of eurozone countries, their persistence and co-movements, with particular attention given to the impact of the financial crisis. Specifically, using a dual fractional integration model, we test the evidence of long memory for CDSs of ten eurozone countries. Our analysis reveals that price discovery processes satisfy the minimum requirements for a weak form of efficiency for sovereign CDS markets, even during the crisis. In contrast, we document the spreading out of persistent CDS uncertainty among the peripheral economies with its outbreak. We provide evidence that CDS uncertainty has implications for the pricing of sovereign risk including that of core countries in the crisis period. Finally, we present the potential spillover effects utilizing a dynamic q The authors wish to thank to the managing guest editor
Ambivalent Change in CDS Spreads in 11 Euro Area Countries
Pénzügyi Szemle = Public Finance Quarterly, 2022
One of the macroeconomic consequences of the COVID-19 epidemic is that the global economy has seen a robust increase in the countries‘ gross external debt and the sovereign public debt that is part of it. Nor have the eurozone Member States escaped this effect. The increase in gross external debt and sovereign government debt also means that it has become theoretically more risky for investors to buy debt securities (typically bonds). Theoretically, however, it follows that as a result of the increase in risks in the country, CDS spreads had to rise as well. The study uses a correlation calculation to show that the development of the price of CDSs is more closely correlated with gross government debt than with gross external debt. Using hierarchical cluster analysis, the study groups the countries of the Eurozone. The basis for clustering is the close relationship between a country‘s gross government debt and its CDS spread over the period under review. A relevant conclusion of the ...
Bank fragility and contagion: Evidence from the bank CDS market
Journal of Empirical Finance, 2016
Understanding how contagion works among financial institutions is a top priority for regulators and policy makers who aim to foster financial stability and to prevent financial crises. Using bank credit default swap (CDS) data, we provide a framework for the evaluation of contagion among banks in different countries and regions during a period of prolonged financial distress. We measure contagion in terms of return spillovers, following a Generalized VAR (GVAR) approach. In addition, we propose an innovative framework to distinguish between two types of contagion: systematic (linked to global factors), and idiosyncratic (linked to bank specific factors). We find evidence of both types of contagion, although the spillover dynamics changed over time. Our measure of systematic contagion is always greater than the idiosyncratic component, thus highlighting the importance of common factors in the propagation of risk spillovers. This indicates that international linkages among banking markets are central to the transmission of shocks.
CDS AND STOCK MARKET: PANEL EVIDENCE UNDER CROSS-SECTION DEPENDENCY
In recent years, the spreads of CDS that are crucial aspects in detecting the financial risk level of countries have been taken more notice of by investors. In this paper, we investigate the relation between CDS spreads and countries’ stock indices by using Basher and Westerlund (2009) panel cointegration and DumitrescuHurlin (2012) panel causality tests. Causality from stock market to CDS figures has been detected by the Sequential Panel Selection Method (SPSM) of Chortareas and Kapetanios (2009) for 7 out of 13 G20 countries. Additionally, the study finds a negative correlation between variables with the usage of Common Correlated Effects (CCE) estimator. The positive increasing trend in stock markets causes a decrease in the financial risks that naturally allow low CDS spreads. JEL Classification: C33, G15 Key words: CDS Spread, Stock Market, Panel Cointegration, Panel Causality, Cross-Section Dependency
Contagion in CDS, Banking and Equity Markets
Economic Systems, 2015
The views expressed in this work are those of the authors and do not necessarily reflect those of the Banco Central or its members. Although these Working Papers often represent preliminary work, citation of source is required when used or reproduced. As opiniões expressas neste trabalho são exclusivamente do(s) autor(es) e não refletem, necessariamente, a visão do Banco Central do Brasil. Ainda que este artigo represente trabalho preliminar, é requerida a citação da fonte, mesmo quando reproduzido parcialmente.
Bank Fragility and Contagion: Evidence from the CDS market
2013
Preliminary and Incomplete Draft- Please do not quote This paper provides an evaluation of contagion among banks and banking sectors in different countries and regions during a period of prolonged financial distress. Using banks CDS spreads as an indicator of bank risk, we investigate contagion in banking markets during the period January 2004 to March 2013. Following a Generalised VAR (GVAR) approach, we distinguish between two types of contagion: systematic contagion (linked to global factors), and idiosyncratic contagion (linked to bank specific factors). While the overall contagion was driven by the systematic component during the global financial crisis, with US banks being net transmitters, the idiosyncratic component becomes more relevant during the Eurozone crisis. US banks are not receiving instability from Eurozone banks. Banks in EU peripheral countries are net transmitters of idiosyncratic contagion whereas banks in Euro-Core countries are net transmitters of systematic ...
Risk spillovers in oil-related CDS, stock and credit markets
Energy Economics, 2013
This paper examines risk transmission and migration among six US measures of credit and market risk during the full period 2004-2011 period and the 2009-2011 recovery subperiod, with a focus on four sectors related to the highly volatile oil price. There are more long-run equilibrium risk relationships and short-run causal relationships among the four oil-related Credit Default Swaps (CDS) indexes, the (expected equity volatility) VIX index and the (swaption expected volatility) SMOVE index for the full period than for the recovery subperiod. The auto sector CDS spread is the most error-correcting in the long run and also leads in the risk discovery process in the short run. On the other hand, the CDS spread of the highly regulated, natural monopoly utility sector does not error correct. The four oil-related CDS spread indexes are responsive to VIX in the short-and long-run, while no index is sensitive to SMOVE which, in turn, unilaterally assembles risk migration from VIX. The 2007-2008 Great Recession seems to have led to "localization" and less migration of credit and market risk in the oil-related sectors.
Mathematics, 2020
This study complements the current literature, providing a thorough investigation of the lead–lag connection between stock indices and sovereign credit default swap (CDS) returns for 14 European countries and the US over the period 2004–2016. We use a rolling VAR framework that enables us to analyse the connection process over time covering both crisis and non-crisis periods. In addition, we analyse the relationship between stock market volatility and CDS returns. We find that the connection between the credit and equity markets does exist and that it is time variable and seems to be related to financial crises. We also observe that stock market returns anticipate sovereign CDS returns, and sovereign CDSs anticipate the conditional volatility of equity returns, closing a connectedness circle between markets. Contribution percentages in terms of returns are more intense in the US than in Europe and the opposite result is found with respect to volatilities. Within Europe, a greater im...