Credit Contagion from Counterparty Risk

48 Pages Posted: 30 Dec 2008

See all articles by Philippe Jorion

Philippe Jorion

University of California, Irvine - Paul Merage School of Business

Gaiyan Zhang

University of California, Irvine

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Date Written: December 30, 2008

Abstract

Standard credit risk models cannot explain the observed clustering of default, sometimes described as "credit contagion." This paper provides the first empirical analysis of credit contagion via direct counterparty effects. We find that bankruptcy announcements cause negative abnormal equity returns and increases in CDS spreads for creditors. In addition, creditors with large exposures are more likely to suffer from financial distress later. This suggests that counterparty risk is a potential additional channel of credit contagion. Indeed, the fear of counterparty defaults among financial institutions explains the sudden worsening of the credit crisis after the Lehman bankruptcy in September 2008.

Keywords: credit risk, counterparty risk, contagion

JEL Classification: G11, G14, G21, G33

Suggested Citation

Jorion, Philippe and Zhang, Gaiyan, Credit Contagion from Counterparty Risk (December 30, 2008). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1321670

Philippe Jorion (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Campus Drive
Irvine, CA 92697-3125
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949-824-5245 (Phone)
949-824-8469 (Fax)

Gaiyan Zhang

University of California, Irvine ( email )

Campus Drive
Irvine, CA 62697-3125
United States

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