City Research Online

Abstract

The global crisis of 2007-2008 is the most severe crisis since the Great Depression in the financial markets. Starting with the subprime defaults in the United States, it quickly spills over into other markets leading to the collapses of many financial institutions, bail-outs of banks worldwide and downturns in asset prices. The aim of this thesis is to investigate the repercussions of this crisis on CDS and interbank market and provide empirical evidence on the changes in the pricing of CDS contracts and interbank deposits.

Chapter 2 discusses the determinants of CDS spread changes on European contracts. The most remarkable finding of the study is that the relation between credit spreads and their determinants is regime dependant and depends on the sector of economic activity. Before the crisis the underlying credit risk in the overall CDS market is sufficient to explain credit risk. During the crisis investors have a differing view on the risk of financial and non--financial contracts
Interestingly, non-financial CDS contracts reflect the credit risk of the counterparty, but financial contracts do not. This implies that governments are expected to bail out dealers to prevent systemic risk.

Chapter 3 provides further insight into the European corporate CDS spreads and proposes an equilibrium model accommodating the occurrence of structural breaks in the long-run relationship between the variables. These breaks are endogenously determined within unit root specifications used to describe the dynamics of the explanatory factors. The findings highlight that crisis shocks are persistent and have the potential to change long-run equilibrium dynamics. The systematic credit risk factor is proxied by the European iTraxx index and the idiosyncratic factor by the stock price of reference entity. The model indicates that stock market leads price discovery process. Vector error correction model confirms the strong predictive ability of the iTraxx index and the error correcting vector for changes in the CDS spreads.

Chapter 4 focuses on European interbank market and has two main contributions. First, it estimates the cross-sectional density of interbank funding rates using nonparametric kernel methods. Second, it analyzes the effect of banks size, the operating currency and banks' nationality on the cross-sectional distribution of these rates. The findings strongly support the statistical significance of these effects and highlight the importance of these factors as early warning indicators of financial distress. Prior to the crisis, the borrowing segment of the market exhibits distinctive features such as highly volatile and multimodal distributions suggesting the occurrence of distortions in the cross-section of funding rates. During crisis, large domestic banks operating in Euros enjoy the most favourable rates. Banks' nationality analysis further confirms that interbank market provided early warning signals of incoming sovereign crisis.

Publication Type:	Thesis (Doctoral)
Subjects:	H Social Sciences > HC Economic History and Conditions
Departments:	School of Policy & Global Affairs > Economics Doctoral Theses School of Policy & Global Affairs > School of Policy & Global Affairs Doctoral Theses

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