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What determines euro area bank CDS spreads? National Bank of Belgium Working Paper, No. 190, May 2010

Annaert, Jan and De Ceuster, Marc and Van Roy, Patrick and Vespro, Cristina. (2010) What determines euro area bank CDS spreads? National Bank of Belgium Working Paper, No. 190, May 2010. [Working Paper]

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    Abstract

    This paper decomposes the explained part of the CDS spread changes of 31 listed euro area banks according to various risk drivers. The choice of the credit risk drivers is inspired by the Merton (1974) model. Individual CDS liquidity and other market and business variables are identified to complement the Merton model and are shown to play an important role in explaining credit spread changes. Our decomposition reveals, however, highly changing dynamics in the credit, liquidity, and business cycle and market wide components. This result is important since supervisors and monetary policy makers extract different signals from liquidity based CDS spread changes than from business cycle or credit risk based changes. For the recent financial crisis, we confirm that the steeply rising CDS spreads are due to increased credit risk. However, individual CDS liquidity and market wide liquidity premia played a dominant role. In the period before the start of the crisis, our model and its decomposition suggest that credit risk was not correctly priced, a finding which was correctly observed by e.g. the International Monetary Fund.

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    Item Type: Working Paper
    Uncontrolled Keywords: Credit default spreads; credit risk; financial crisis; financial sector; liquidity premia; structural model.
    Subjects for non-EU documents: EU policies and themes > Policies & related activities > economic and financial affairs > Single Market > capital, goods, services, workers
    EU policies and themes > Policies & related activities > economic and financial affairs > financial crisis 2008-on and consequences/reforms
    Other international institutions > IMF
    Subjects for EU documents: UNSPECIFIED
    EU Series: UNSPECIFIED
    ["eprint_fieldname_eusries" not defined]: UNSPECIFIED
    EU Annual Reports: UNSPECIFIED
    Series: Series > National Bank of Belgium (Brussels) > Working Papers
    Depositing User: Phil Wilkin
    Official EU Document: No
    Language: English
    Date Deposited: 02 Aug 2010
    Page Range: p. 38
    Last Modified: 15 Feb 2011 18:33
    URI: http://aei.pitt.edu/id/eprint/14458

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