The determinants of bank CDS spreads: Evidence from the financial crisis

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Chiaramonte, L. ; Casu, B. (2012)

Based on a sample of mid-lier and top-tier internationally active banks with 5-year senior CDS, this paper investigates the determinants of credit default swaps (CDS) spreads and whether CDS spreads can be considered a good proxy of bank performance. The analysis encompasses three time periods: a pre-crisis period (1 January 2005-30 June 2007), a crisis period (1 July 2007-31 March 2009) and a post-crisis period (1 April 2009-30 June 2011) and focuses exclusively on bank-specific balance sheet ratios. The results of the empirical analysis indicate that bank CDS spreads, both in the pre-crisis period, but especially in the crisis period, reflect the risk captured by bank balance sheet ratios. We find that the determinants of bank CDS spreads vary strongly across lime, as economic and financial conditions vary. TIER 1 ratio and leverage appear insignificant in all of the three periods considered, while liquidity indicators become significant only during the crisis and post crisis period.
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