The Fundamental Determinants of Credit Default Risk for European Large Complex Financial Institutions

June 1, 2010

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Format: Chicago

Jiri Podpiera, and Inci Ötker. The Fundamental Determinants of Credit Default Risk for European Large Complex Financial Institutions, (USA: International Monetary Fund, 2010) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper attempts to identify the fundamental variables that drive the credit default swaps during the initial phase of distress in selected European Large Complex Financial Institutions (LCFIs). It uses yearly data over 2004 - 08 for 29 European LCFIs. The results from a dynamic panel data estimator show that LCFIs’ business models, earnings potential, and economic uncertainty (represented by market expectations about the future risks of a particular LCFI and market views on prospects for economic growth) are among the most significant determinants of credit risk. The findings of the paper are broadly consistent with those of the literature on bank failure, where the determinants of the latter include the entire CAMELS structure - that is, Capital Adequacy, Asset Quality, Management Quality, Earnings Potential, Liquidity, and Sensitivity to Market Risk. By establishing a link between the financial and market fundamentals of LCFIs and their CDS spreads, the paper offers a potential tool for fundamentals-based vulnerability and early warning system for LCFIs.

Subject: Banking, Credit default swap, Credit risk, Debt default, Yield curve

Keywords: CDS market, CDS spread, Cost of funds, Market risk, WP

Publication Details

Pages:

31
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2010/153
Stock No:

WPIEA2010153
ISBN:

9781455201365
ISSN:

1018-5941

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