Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/52454 
Year of Publication: 
2011
Series/Report no.: 
CESifo Working Paper No. 3583
Publisher: 
Center for Economic Studies and ifo Institute (CESifo), Munich
Abstract: 
This paper addresses the impact of developments in the credit risk transfer market on the viability of a group of systemically important financial institutions. We propose a bank default risk model, in the vein of the classic Merton-type, which utilizes a multi-equation framework to model forward-looking measures of market and credit risk using the credit default swap (CDS) index market as a measure of the global credit environment. In the first step, we establish the existence of significant detrimental volatility spillovers from the CDS market to the banks' equity prices, suggesting a credit shock propagation channel which results in serious deterioration of the valuation of banks' assets. In the second step, we show that substantial capital injections are required to restore the stability of the banking system to an acceptable level after shocks to the CDX and iTraxx indices. Our empirical evidence thus informs the relevant regulatory authorities on the magnitude of banking systemic risk jointly posed by CDS markets.
Subjects: 
distance of default
credit derivatives
credit default swap index
financial stability
JEL: 
C32
G21
G33
Document Type: 
Working Paper
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