Credit risk

About: Credit risk is a research topic. Over the lifetime, 18595 publications have been published within this topic receiving 382866 citations.

Pricing Swap Default Risk

Abstract: With the growth in the market for interest rate swaps has come a growing need to understand the potential default risks of these instruments. In general, swap participants can deal with default risk by seeking to mitigate it (by dealing only with AAA-rated counterparties, for example). Alternatively, potential counterparties can attempt to come to some agreement about the degree of default risk and use that knowledge to "price" their positions. A model of swap default risk evaluates jointly the probability of the swap counterparty defaulting and the cost (or impact) of the default for the solvent party. The model helps to establish the correct level for a swap between risky (or potentially risky) parties. The key considerations are the swap parties' credit conditions and the shape and volatility of the yield curve.

Sovereign credit ratings : guilty beyond reasonable doubt?

Abstract: This paper questions the view that credit rating agencies aggravated the East Asian crisis by excessively downgrading those countries. I find that ratings are, if anything, sticky rather than procyclical. Assigned ratings exceeded predicted ratings before the crisis, mostly matched predicted ratings during the crisis period, and did not increase as much as predictions in the period after the crisis. Ratings are also found to react to non-macroeconomic factors such as lagged spreads and a country’s default history. Therefore it is questionable that ratings exacerbate the boom-bust cycle if they are simply reacting to news, whether macroeconomic or market.

Precautionary hoarding of liquidity and inter-bank markets: Evidence from the sub-prime crisis

Abstract: We study the liquidity demand of large settlement (first-tier) banks in the UK and its effect on the Sterling Money Markets before and during the sub-prime crisis of 2007-08 Liquidity holdings of large settlement banks experienced on average a 30% increase in the period immediately following 9th August, 2007, the day when money markets froze, igniting the crisis In the UK, unlike in the US until October 2008, the remuneration of reserves accounts provides strong incentives for banks to park liquidity at the central bank rather than lend in the market We show that following this structural break, settlement bank liquidity had a precautionary nature in that it rose on calendar days with a large amount of payment activity and for banks with greater credit risk We establish that the liquidity demand by settlement banks caused overnight inter-bank rates to rise and volumes to decline, an effect virtually absent in the pre-crisis period This liquidity effect on inter-bank rates occurred in both unsecured borrowing as well as borrowing secured by UK government bonds Further, using bilateral data we show that the effect was more strongly linked to lender risk than to borrower risk

The Interbank Market after the Financial Turmoil: Squeezing Liquidity in a 'Lemons Market' or Asking Liquidity 'on Tap'

Abstract: After August 2007 the plumbing system that supplied banks with wholesale funding, the interbank market, failed because toxic assets obstructed the pipes. Banks were forced to squeeze liquidity in a 'lemons market' or to ask for liquidity 'on tap' from central banks. This paper disentangles the two components of the three-month Euribor-Eonia swap spread, credit and liquidity risk and then evaluates the decomposition. The main finding is that credit risk increased before the key events of the crisis, while liquidity risk was mainly responsible for the subsequent increases in the Euribor spread and then reacted to the systemic responses of the central banks, especially in October 2008. Moreover, the level of the spread between May 2009 and February 2010 was influenced mainly by credit risk, suggesting that European banks were still in a 'lemons market' and relied on liquidity 'on tap'.