Working Paper

Identifying Contagion in a Banking Network

Abstract: We present the first micro-level evidence of the transmission of shocks through financial networks. Using the network of credit default swap (CDS) transactions between banks, we identify bank CDS returns attributable to counterparty losses. A bank's own CDS spread increases whenever counterparties from whom it has purchased default protection themselves experience losses. We find no such effect from losses of non-counterparties, nor from counterparties to whom the bank has sold protection. The effect on bank CDS returns through this counterparty loss channel is large relative to the direct effect on a bank's CDS returns from its own trading losses.

Keywords: Contagion; Counterparty risk; Credit default swaps; Networks;

JEL Classification: G21; G23; L14;

https://doi.org/10.17016/FEDS.2017.082

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2017-08-15

Number: 2017-082

Pages: 36 pages