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Credit derivatives and the default risk of large complex financial institutions

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posted on 24.02.2017 by Giovanni Calice, Christos Ioannidis, Julian M. Williams
This paper proposes and implements a multivariate model of the coevolution of the first and second moments of two broad credit default swap indices and the equity prices of sixteen large complex financial institutions. We use this empirical model to build a bank default risk model, in the vein of the classic Merton-type, which utilises 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 conditions of the global credit environment. In the first step, we estimate the dynamic correlations and volatilities describing the evolution of the CDS indices and the banks’ equity prices and then impute the implied assets and their volatilities conditional on the evolution and volatility of equity. In the second step, we show that there is a substantial ‘asset shortfall’ and that substantial capital injections and/or asset insurance are required to restore the stability of our sample institutions to an acceptable level following large shocks to the aggregate level of credit risk in financial markets.

History

School

  • Business and Economics

Department

  • Business

Published in

Journal of Financial Services Research

Volume

42

Issue

1-2

Pages

85 - 107

Citation

CALICE, G., IOANNIDIS, C. and WILLIAMS, J.M., 2012. Credit derivatives and the default risk of large complex financial institutions. Journal of Financial Services Research, 42 (1-2), pp.85-107

Publisher

© Springer Science+Business Media, LLC

Version

AM (Accepted Manuscript)

Publisher statement

This work is made available according to the conditions of the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International (CC BY-NC-ND 4.0) licence. Full details of this licence are available at: https://creativecommons.org/licenses/by-nc-nd/4.0/

Acceptance date

01/09/2011

Publication date

2012

Notes

This paper is available online at: http://dx.doi.org/10.1007/s10693-011-0121-z

ISSN

0920-8550

eISSN

1573-0735

Language

en

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