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Looking through systemic credit risk: determinants, stress testing and market value

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Chamizo Cana, Álvaro and Novales Cinca, Alfonso Looking through systemic credit risk: determinants, stress testing and market value. [ Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE); nº 27, 2019, ISSN: 2341-2356 ]

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Abstract

We provide a methodology to estimate a Global Credit Risk Factor (GCRF) from CDS spreads using the information provided by the default-related component of observed spreads. These are previ- ously estimated using Pan and Singleton (2008) methodology. The estimated factor contains higher explanatory power on CDS spread fluctuations across sectors than standard credit indices like iTraxx or CDX. We find a positive association between GCRF and implied volatility variables, and a negative association with MSCI stock market sector indices as well as with interest rates and with the slope and the curvature of the term structure. Such correlations provide useful insights for risk management as well as for the hedging of credit portfolios. Indeed, we present a synthetic factor regression model for GCRF that we apply in a stress testing methodology for credit portfolios as well as to evaluate future credit risk scenarios. Finally, we show evidence suggesting that the exposure to systemic credit risk was priced in the market during the 2006-2015 period.


Item Type:Working Paper or Technical Report
Additional Information:

We thank Pedro Serrano for comments and suggestions on a previous version of the paper.

Preprint submitted to Elsevier. 31st August 2019.

Uncontrolled Keywords:Credit Risk; Systemic Risk; Idiosyncratic Risk; Stress Tests; Factor Models; Market Pricing.
Subjects:Social sciences > Economics > Econometrics
Social sciences > Economics > Finance
JEL:E44, F34, G01, G11, G23, G32
Series Name:Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE)
Volume:2019
Number:27
ID Code:57137
Deposited On:30 Sep 2019 08:56
Last Modified:17 Oct 2019 12:08

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