Credit derivatives and the default risk of large complex financial institutions

Giovanni Calice, Christos Ioannidis, Julian Williams

Research output: Contribution to journalArticlepeer-review


This paper proposes and implements a multivariate model of the coevolution of the first and second moments of two broad credit default swap indices and the equity prices of sixteen large complex financial institutions. We use this empirical model to build a bank default risk model, in the vein of the classic Merton-type, which utilises a multi-equation framework to model forward-looking measures of market and credit risk using the credit default swap (CDS) index market as a measure of the conditions of the global credit environment. In the first step, we estimate the dynamic correlations and volatilities describing the evolution of the CDS indices and the banks’ equity prices and then impute the implied assets and their volatilities conditional on the evolution and volatility of equity. In the second step, we show that there is a substantial ‘asset shortfall’ and that substantial capital injections and/or asset insurance are required to restore the stability of our sample institutions to an acceptable level following large shocks to the aggregate level of credit risk in financial markets.
Original languageEnglish
Pages (from-to)85-107
Number of pages23
JournalJournal of Financial Services Research
Issue number1-2
Publication statusPublished - Oct 2012


  • distance to default
  • credit derivatives
  • credit default swap index


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