The relationship between distance-to-default and CDS spreads as measures of default risk for European banks
CDS spreads are often seen as the ’leading’ market based, default risk measure. There is no popular alternative to CDS spreads except perhaps for the distance-to-default (D2D) measure based on Merton (1974), which comes very close to it. In this paper, we investigate the correlation and short-ter...
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| Format: | Article |
| Language: | English |
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University of Warsaw
2016-04-01
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| Series: | Journal of Banking and Financial Economics |
| Subjects: | |
| Online Access: | https://jbfe.wz.uw.edu.pl/resources/html/article/details?id=198301 |
| _version_ | 1797226808144297984 |
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| author | Kim Ristolainen |
| author_facet | Kim Ristolainen |
| author_sort | Kim Ristolainen |
| collection | DOAJ |
| description | CDS spreads are often seen as the ’leading’ market based, default risk measure. There is no
popular alternative to CDS spreads except perhaps for the distance-to-default (D2D) measure
based on Merton (1974), which comes very close to it. In this paper, we investigate the correlation
and short-term dynamics between these two measures for large European banks with a data panel
spanning from 1/2006 to 12/2013. The analysis makes use of conventional Granger causality test
statistics for individual banks and for the whole panel data. As regards the results, we found that
the lead-lag relationship between these highly related variables varies over time, over different
banks, and over economic regimes. The lead of D2D is signifi cantly stronger for banks that are
smaller relative to the other banks in the sample, banks in problem countries (PIIGS), after global
fi nancial crises, during market turmoil, and for banks with poor credit quality indicated by a high
CDS spread. These results and the fact that D2D can be calculated for every bank quoted on the
stock exchange suggests that D2D is a promising alternative to the CDS spread in default risk
assessment of banks. |
| first_indexed | 2024-04-24T14:30:47Z |
| format | Article |
| id | doaj.art-1b2da732a63e4679a930a474e8c34cd4 |
| institution | Directory Open Access Journal |
| issn | 2353-6845 |
| language | English |
| last_indexed | 2024-04-24T14:30:47Z |
| publishDate | 2016-04-01 |
| publisher | University of Warsaw |
| record_format | Article |
| series | Journal of Banking and Financial Economics |
| spelling | doaj.art-1b2da732a63e4679a930a474e8c34cd42024-04-03T02:34:11ZengUniversity of WarsawJournal of Banking and Financial Economics2353-68452016-04-0120161(5)12114310.7172/2353-6845.jbfe.2016.1.5The relationship between distance-to-default and CDS spreads as measures of default risk for European banksKim Ristolainen0University of Turku, FinlandCDS spreads are often seen as the ’leading’ market based, default risk measure. There is no popular alternative to CDS spreads except perhaps for the distance-to-default (D2D) measure based on Merton (1974), which comes very close to it. In this paper, we investigate the correlation and short-term dynamics between these two measures for large European banks with a data panel spanning from 1/2006 to 12/2013. The analysis makes use of conventional Granger causality test statistics for individual banks and for the whole panel data. As regards the results, we found that the lead-lag relationship between these highly related variables varies over time, over different banks, and over economic regimes. The lead of D2D is signifi cantly stronger for banks that are smaller relative to the other banks in the sample, banks in problem countries (PIIGS), after global fi nancial crises, during market turmoil, and for banks with poor credit quality indicated by a high CDS spread. These results and the fact that D2D can be calculated for every bank quoted on the stock exchange suggests that D2D is a promising alternative to the CDS spread in default risk assessment of banks.https://jbfe.wz.uw.edu.pl/resources/html/article/details?id=198301fi nancial stabilityeuropean banksdistance-to-defaultcredit default swaplead-lag relationship |
| spellingShingle | Kim Ristolainen The relationship between distance-to-default and CDS spreads as measures of default risk for European banks Journal of Banking and Financial Economics fi nancial stability european banks distance-to-default credit default swap lead-lag relationship |
| title | The relationship between distance-to-default and CDS spreads as measures of default risk for European banks |
| title_full | The relationship between distance-to-default and CDS spreads as measures of default risk for European banks |
| title_fullStr | The relationship between distance-to-default and CDS spreads as measures of default risk for European banks |
| title_full_unstemmed | The relationship between distance-to-default and CDS spreads as measures of default risk for European banks |
| title_short | The relationship between distance-to-default and CDS spreads as measures of default risk for European banks |
| title_sort | relationship between distance to default and cds spreads as measures of default risk for european banks |
| topic | fi nancial stability european banks distance-to-default credit default swap lead-lag relationship |
| url | https://jbfe.wz.uw.edu.pl/resources/html/article/details?id=198301 |
| work_keys_str_mv | AT kimristolainen therelationshipbetweendistancetodefaultandcdsspreadsasmeasuresofdefaultriskforeuropeanbanks AT kimristolainen relationshipbetweendistancetodefaultandcdsspreadsasmeasuresofdefaultriskforeuropeanbanks |