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Modeling US bank CDS spreads during the Global Financial Crisis with a deferred filtration pricing model

Author

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  • Peter Spencer
Abstract
This paper uses a simplified version of the Duffie and Lando (2002) deferred filtration model to handle the effect of asymmetric information about US banks asset portfolios during the recent crisis, when banks were reluctant to lend to one another because they were not sure about the balance sheet strength of the counterparty and its ability to repay. The accounting lag in the deferred filtration model gives a very useful way of calibrating this uncertainty and provides convenient closed forms suitable for econometric models. I use these to model the default probabilities implied by CDS rates. Comparing the fit of this model with that of the standard full information structural defaultable debt pricing model strongly supports the hypothesis that investors were wary of the value of accounting information. The performance of the model is comparable to that of a benchmark reduced form hazard rate model, the workforce of the empirical literature to date.

Suggested Citation

  • Peter Spencer, 2013. "Modeling US bank CDS spreads during the Global Financial Crisis with a deferred filtration pricing model," Discussion Papers 13/18, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:13/18
    as

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    References listed on IDEAS

    as
    1. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    2. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-664, May.
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    4. Leland, Hayne E & Toft, Klaus Bjerre, 1996. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
    5. Spencer, Peter, 2014. "The Mills Ratio and the behavior of redeemable bond prices in the Gaussian structural model of corporate default," Finance Research Letters, Elsevier, vol. 11(1), pages 8-15.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    deferred filtration; default risk; credit crunch; CDS spread; LIBOR;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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