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Working Paper
Explaining credit default swap spreads with the equity volatility and jump risks of individual firms
Zhang, Benjamin Y.; Zhou, Hao; Zhu, Haibin (2005)
A structural model with stochastic volatility and jumps implies specific relationships between observed equity returns and credit spreads. This paper explores such effects in the credit default swap (CDS) market. We use a novel approach to identify the realized jumps of individual equities from high frequency data. Our empirical results suggest that volatility risk alone predicts 50 percent of the variation in CDS spreads, while jump risk alone forecasts 19 percent. After controlling for credit ratings, macroeconomic conditions, and firms' balance sheet information, we can explain 77 percent ...
Finance and Economics Discussion Series , Paper 2005-63

Working Paper
Parameterizing credit risk models with rating data
Carey, Mark S.; Hrycay, Mark (2000)
Estimates of average default probabilities for borrowers assigned to each of a financial institution's internal credit risk rating grades are crucial inputs to portfolio credit risk models. Such models are increasingly used in setting financial institution capital structure, in internal control and compensation systems, in asset-backed security design, and are being considered for use in setting regulatory capital requirements for banks. This paper empirically examines properties of the major methods currently used to estimate average default probabilities by grade. Evidence of potential ...
Finance and Economics Discussion Series , Paper 2000-47

Working Paper
Market discipline in banking reconsidered: the roles of deposit insurance reform, funding manager decisions and bond market liquidity
Hancock, Diana; Covitz, Daniel M.; Kwast, Myron L. (2002)
This paper demonstrates that the risk sensitivity of a banking organization's subordinated debt yield spreads may understate the potential for market discipline in some periods and overstate in others because such spreads contain liquidity premiums that are driven, in part, by the risk-sensitivity of funding manager decisions. Once such decisions are accounted for, new evidence is provided that indicates that subordinated debt spreads were sensitive to organization-specific risks in the mid-1980s, and that the risk- sensitivity of such spreads was about the same in the pre- and post-FDICIA ...
Finance and Economics Discussion Series , Paper 2002-46

Working Paper
A coherent framework for stress-testing
Berkowitz, Jeremy (1999)
In recent months and years both practitioners and regulators have embraced the ideal of supplementing VaR estimates with "stress-testing". Risk managers are beginning to place an emphasis and expend resources on developing more and better stress-tests. In the present paper, we hold the standard approach to stress-testing up to a critical light. The current practice is to stress-test outside the basic risk model. Such an approach yields two sets of forecasts -- one from the stress-tests and one from the basic model. The stress scenarios, conducted outside the model, are never explicitly ...
Finance and Economics Discussion Series , Paper 1999-29

Working Paper
Testing for market discipline in the European banking industry: evidence from subordinated debt issues
Sironi, Andrea (2000)
The question of whether private investors can rationally discriminate between the risk taken by banks is empirically investigated by testing the risk sensitivity of European banks' subordinated notes and debentures (SND) spreads. A unique dataset of issuance spreads, issues and issuers rating, accounting and market measures of bank risk is used for a sample of European banks' SND issued during the 1991-2000:Q1 period. Moody's Bank Financial Strength (MBFS) and FitchIBCA Individual (FII) ratings are used as proxies of banks risk and found to perform better than accounting variables in ...
Finance and Economics Discussion Series , Paper 2000-40

Working Paper
Spectral Backtests of Forecast Distributions with Application to Risk Management
McNeil, Alexander J.; Gordy, Michael B. (2018-03-23)
We study a class of backtests for forecast distributions in which the test statistic is a spectral transformation that weights exceedance events by a function of the modeled probability level. The choice of the kernel function makes explicit the user's priorities for model performance. The class of spectral backtests includes tests of unconditional coverage and tests of conditional coverage. We show how the class embeds a wide variety of backtests in the existing literature, and propose novel variants as well. In an empirical application, we backtest forecast distributions for the overnight ...
Finance and Economics Discussion Series , Paper 2018-021

Working Paper
An analysis of European banks SND issues and its implications for the design of a mandatory subordinated debt policy
Sironi, Andrea (2000)
During the last twenty years an increasing number of proposals to improve bank market discipline through the introduction of a mandatory subordinated debt policy have been drafted and critically discussed by academic economists and bank regulators. While theoretical issues are key in this debate, a proper understanding of the market of banks' subordinated notes and debentures (SND) and of the securities main features is also considered as relevant for the potential introduction, design, and goals setting of such a policy. This paper builds on information concerning issuers, investors, ...
Finance and Economics Discussion Series , Paper 2000-41

Working Paper
Does Hedging with Derivatives Reduce the Market's Perception of Credit Risk?
Tookes, Heather; Anbil, Sriya; Saretto, Alessio (2016-07-20)
Risk management is the most widely-cited reason that non-financial corporations use derivatives. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Surprisingly, we find that firms with derivative positions without a hedge accounting designation (typically higher basis risk) have higher CDS spreads than firms that do not hedge at all. We do not find evidence that these non-designated positions are associated with future credit realizations. We examine alternative explanations and find evidence that is consistent with a market ...
Finance and Economics Discussion Series , Paper 2016-100

Working Paper
Granularity adjustment for mark-to-market credit risk models
Gordy, Michael B.; Marrone, James (2010)
The impact of undiversified idiosyncratic risk on value-at-risk and expected shortfall can be approximated analytically via a methodology known as granularity adjustment (GA). In principle, the GA methodology can be applied to any risk-factor model of portfolio risk. Thus far, however, analytical results have been derived only for simple models of actuarial loss, i.e., credit loss due to default. We demonstrate that the GA is entirely tractable for single-factor versions of a large class of models that includes all the commonly used mark-to-market approaches. Our approach covers both finite ...
Finance and Economics Discussion Series , Paper 2010-37

Working Paper
Half-full or Half-empty? Financial Institutions, CDS Use, and Corporate Credit Risk
Parolin, Eric; Darst, Matt; Caglio, Cecilia R. (2018-07-19)
We construct a novel U.S. data set that matches bank holding company credit default swap (CDS) positions to detailed U.S. credit registry data containing both loan and corporate bond holdings to study the effects of banks' CDS use on corporate credit quality. Banks may use CDS to mitigate agency frictions and not renegotiate loans with solvent but illiquid borrowers resulting in poorer measures of credit risk. Alternatively, banks may lay off the credit risk of high quality borrowers through the CDS market to comply with risk-based capital requirements, which does not impact corporate credit ...
Finance and Economics Discussion Series , Paper 2018-047

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