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Analysis of the CDS Market: risk, contagion and evaluation

13rd National Competition for Economic Research Grants

International economics

Senior Researcher : Laura Ballester Miquel

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Research Centre or Institution : Universidad de Valencia.

Abstract

The current global financial crisis, and the crisis in the euro-zone in particular, has meant that questions related to the functioning, functions and relations among the financial markets are more relevant than ever. The vulnerability of the financial entities is still today a fact of great importance, mainly due to the large amount of sovereign debt they hold. Consequently, there has been increasing concern about the solvency and credit risk of both the banking systems and sovereign debt.

In this context, analysing and quantifying the channels for the transmission of credit risk and its volatility in financial entities and sovereign states, as well as their relations with other key variables in the financial markets and the measurement and evaluation of that risk, represent key themes for analysis from the academic, professional and institutional point of view.

More precisely, taking the CDS (Credit Default Swaps) market, considered a good approximation of the credit risk, as the main focus, this project pursues four different though closely related objectives. First of all, it will analyse the transmission of credit risk in the European banking sector, considering a long period which encompasses the recent European subprime and sovereign debt crisis. Secondly, it will study the relations of causality in the medium term between sovereign CDSs, the exchange rate and the stock exchange indices in the Euro-zone. Thirdly, it will analyse the contagion and impact of announcements of changes in ratings on the sovereign CDSs of emerging countries. And finally, it will analyse the counterparty risk through evaluation with BCVA (Bilateral credit value adjustment) and FVA (Funding value adjustment).

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