What determines Euro area bank CDS spreads?

Abstract

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Unveiling Sovereign Effects in European Banks CDS Spreads Variations

“…Gilchrist et al (2011) for instance demonstrated the importance of considering the business cycle perspective in explaining the determinants of credit spreads. Similarly, Berndt et al (2005) suggest that CDS spreads are likely not attributed to credit risk alone and Annaert et al (2013) notably conclude that liquidity and global economic variables are important to explain CDS variations. More recently, Keiler and Eder (2013) investigate the degree of systemic risk and the importance of potential spill-over effects in the banking system by analyzing the determinants of CDS spreads using spatial econometric approach.…”

“…One of the few research performed specifically on banks and covering the period after the subprime crisis is provided by Annaert et al (2013). Analyzing the determinants of CDS spread changes for 32 listed euro area banks over the period 2004 -2010, they find an increasing explanatory power of the variables suggested by structural credit models after the crisis period.…”

“…Hence, inspired by Collin-Dufresne et al (2001) and Annaert et al (2013) but following a methodology suggested by Di Cesare and Guazzarotti (2010), we first determine the distance-to-default component generated by an application of Merton's structural model (1974) and Black & Scholes (1973). Our analysis starts then by comparing such output with the observed historical CDS spreads.…”

“…When a firm defaults, bondholders receive the value of the firm's total asset. Hence, a firm's capital structure can be seen as a combination of options where shareholders are long a European call option (right to "buy" the firm in going concern) and bondholders are short a European put option (obligation to "buy" the firm in default), both with a strike price corresponding to the above-mentioned threshold.While largely used by the literature to examine the determinants of credit spreads (see Alexopoulou et al (2009) or Annaert et al (2013) for a similar statement), structural models are however subject to strong assumptions related notably to the existence of a single debt, the timing of default (at the debt's maturity for the simpler case 15 ) and the absence of costs related to the default.…”

“… For the general level and structure of interest rates: is the weekly change of the risk-free rate at time t proxied by the 10-year EMU bond index obtained from Datastream and represents the term structure slope at time t proxied by the spread between the 10-year EMU bond index and the 2-year EMU bond index;  For the general business climate: following Collin-Dufresne et al (2001), Zhu (2006) and Annaert et al (2013), we include being the market wide stock index return at time t based on the weekly Eurostoxx 50 data obtained from Datastream and following Berndt et al (2005) and Annaert et al (2013), we use being the weekly change in the stock index volatility at time t based on the weekly VSTOXX data obtained from Datastream to measure market wide implied volatility;  Finally, considering that our study aims specifically at the banking industry, we opt for the spread between Libor and OIS as a proxy for the general state of the banking system 17 but also as a reflection of possible market wide liquidity strains. This approach is similar to Keiler (2013).…”