Credit Default Swaps Drawup Networks: Too Tied To Be Stable?

TL;DR

This paper investigates the interconnectedness of major US and European institutions through CDS spread analysis during the financial crisis, revealing significant co-movements and dependencies that highlight systemic risk.

Contribution

It extends existing methods to analyze joint drawups in CDS spreads, providing a network-based approach to understand financial dependencies and systemic importance.

Findings

Significant probability of joint CDS drawups among certain institutions

Evidence of trend reinforcement in CDS spreads

Network analysis highlights key systemic institutions

Abstract

We analyse time series of CDS spreads for a set of major US and European institutions on a pe- riod overlapping the recent financial crisis. We extend the existing methodology of {\epsilon}-drawdowns to the one of joint {\epsilon}-drawups, in order to estimate the conditional probabilities of abrupt co-movements among spreads. We correct for randomness and for finite size effects and we find significant prob- ability of joint drawups for certain pairs of CDS. We also find significant probability of trend rein- forcement, i.e. drawups in a given CDS followed by drawups in the same CDS. Finally, we take the matrix of probability of joint drawups as an estimate of the network of financial dependencies among institutions. We then carry out a network analysis that provides insights into the role of systemically important financial institutions.