Finance and Economics Discussion Series (FEDS)
Identifying Contagion in a Banking Network
Alan Morrison, Michalis Vasios, Mungo Wilson, and Filip Zikes
We present the first micro-level evidence of the transmission of shocks through financial networks. Using the network of credit default swap (CDS) transactions between banks, we identify bank CDS returns attributable to counterparty losses. A bank's own CDS spread increases whenever counterparties from whom it has purchased default protection themselves experience losses. We find no such effect from losses of non-counterparties, nor from counterparties to whom the bank has sold protection. The effect on bank CDS returns through this counterparty loss channel is large relative to the direct effect on a bank's CDS returns from its own trading losses.
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Keywords: Contagion, counterparty risk, credit default swaps, networks
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