Journal of Financial Services Research

, Volume 42, Issue 1, pp 85-107

First online:

Credit Derivatives and the Default Risk of Large Complex Financial Institutions

  • Giovanni CaliceAffiliated withSchool of Management, University of Southampton Email author 
  • , Christos IoannidisAffiliated withDepartment of Economics, University of Bath
  • , Julian WilliamsAffiliated withBusiness School, University of Aberdeen

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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.


Distance to default Credit derivatives Credit default swap index

JEL Classification

G12 G13 G15