Financial Markets and Portfolio Management

, Volume 21, Issue 3, pp 269–292

Credit default swap prices as risk indicators of listed German banks


DOI: 10.1007/s11408-007-0053-7

Cite this article as:
Düllmann, K. & Sosinska, A. Fin Mkts Portfolio Mgmt (2007) 21: 269. doi:10.1007/s11408-007-0053-7


This paper explores empirically the usefulness of credit default swap (CDS) prices as market indicators. The sample of reference entities consists of large, internationally active German banks and the observation period covers 3 years.

By analysing the explanatory power of three risk sources: idiosyncratic credit risk, systematic credit risk and liquidity risk, we gain important insights into modeling the dynamics of CDS spreads. The impact of systematic risk, for example, has three components; one is related to the overall state of the economy, another related to the risk of the internationally active banking sector, and the third is an unobservable systematic factor.

Default probabilities, inferred from a tractable reduced form model for CDS spreads, are compared with expected default frequencies from the Moody’s KMV model. The results lend empirical support to the hypothesis that structural models can be less informative than reduced-form models of CDS spreads in the case of banks with major investment banking activities as the leverage loses explanatory power.

Although the CDS market appears to have matured over the observation period, during certain periods premiums for liquidity risk can increase substantially thus limiting the value of CDS spreads as market indicators. We conclude that equity prices and CDS premia should be considered together to fully exploit the information content of both market indicators and to mitigate their respective drawbacks.


Credit default swaps Credit risk Market indicators Reduced-form models 


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Copyright information

© Swiss Society for Financial Market Research 2007

Authors and Affiliations

  1. 1.Deutsche BundesbankFrankfurtGermany
  2. 2.Universität FrankfurtFrankfurtGermany

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