The Impact of Government Interventions on CDS and Equity Markets

OMI Seminar Series

We investigate the impact of government guarantees on the pricing of default risk in credit and stock markets and, using a Merton-type credit model, provide evidence of a structural break in the valuation of U.S. bank debt in the course of the 2007-2009 financial crisis, manifesting in a lowered default boundary, or, under the pre-crisis regime, in higher stock-implied credit spreads. A possible explanation is the asymmetric treatment of debt and equity in rescue measures, which tend to favor creditors. The discrepancies are driven by several factors including firm size, default correlation, and high ratings, thus corroborating our too-big-to-fail hypothesis.

Location:
Speaker(s):

Zoe Tsesmelidakis & Frederic Schweikhard (MIT)

Date:
Monday, January 30, 2012 - 17:00
to 18:00