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The Market-implied Probability of European Government Intervention in Distressed Banks

Author

Listed:
  • Richard Neuberg

    (Columbia University)

  • Paul Glasserman

    (Columbia University)

  • Benjamin Kay

    (Office of Financial Research)

  • Sriram Rajan

    (Office of Financial Research)

Abstract

New contract terms for credit default swaps (CDS) on banks were introduced in 2014 to cover losses from government intervention and related bail-in events. For many large European banks, CDS spreads are available under both the old and new contract terms; the difference (or basis) between the two spreads measures the market price of protection against losses from certain government actions to resolve distressed banks. We investigate cross-sectional and time series properties of this basis, relative to each bank's CDS spread. We interpret a general decline in the relative basis as a market price-based signal that governments are less likely to bailout banks in distress, but that banks do not yet have sufficient bail-in debt to protect senior bond holders in case of a credit event.

Suggested Citation

  • Richard Neuberg & Paul Glasserman & Benjamin Kay & Sriram Rajan, 2016. "The Market-implied Probability of European Government Intervention in Distressed Banks," Working Papers 16-10, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:16-10
    as

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    File URL: https://www.financialresearch.gov/working-papers/files/OFRwp-2016-10_Market-Implied-Probability-EU-Intervention-Distressed-Banks.pdf
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    References listed on IDEAS

    as
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    4. Schäfer, Alexander & Schnabel, Isabel & Weder di Mauro, Beatrice, 2016. "Bail-in Expectations for European Banks: Actions Speak Louder than Words," CEPR Discussion Papers 11061, C.E.P.R. Discussion Papers.
    5. Ericsson, Jan & Jacobs, Kris & Oviedo, Rodolfo, 2009. "The Determinants of Credit Default Swap Premia," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 109-132, February.
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    Cited by:

    1. Martin Indergand & Gabriela Hrasko, 2021. "Does the market believe in loss-absorbing bank debt?," Working Papers 2021-13, Swiss National Bank.
    2. Office of Financial Research (ed.), 2016. "2016 Financial Stability Report," Reports, Office of Financial Research, US Department of the Treasury, number 16-3, May.
    3. Allen N. Berger & Charles P. Himmelberg & Raluca A. Roman & Sergey Tsyplakov, 2022. "Bank bailouts, bail‐ins, or no regulatory intervention? A dynamic model and empirical tests of optimal regulation and implications for future crises," Financial Management, Financial Management Association International, vol. 51(4), pages 1031-1090, December.
    4. Thorsten Beck & Samuel Da-Rocha-Lopes & André F Silva & Francesca Cornelli, 2021. "Sharing the Pain? Credit Supply and Real Effects of Bank Bail-ins [High wage workers and high wage firms]," The Review of Financial Studies, Society for Financial Studies, vol. 34(4), pages 1747-1788.

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    More about this item

    Keywords

    Credit default swaps; banks; government intervention; European Bank Resolution and Recovery Directive;
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