The Credit Risk Transfer Market and Stability Implications for U.K. Financial Institutions
IMF Working Papers, June 1, 2006
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- The Credit Risk Transfer Market and Stability Implications for U.K. Financial Institutions
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Bibliographic details
- Authors: Li L Ong, Jorge A Chan-Lau
- Published: June 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451863994.001
Summary
- The increasing ability to trade credit risk in financial markets has facilitated its dispersion across the financial and other sectors.
- Specific risks attached to credit risk transfer (CRT) instruments in a market with still-limited liquidity mean that its rapid expansion may actually pose problems for financial sector stability in the event of a major negative shock to credit markets.
- This paper attempts to quantify the exposure of major U.K. financial groups to credit derivatives, by applying a vector autoregression (VAR) model to publicly available market prices.
- Results indicate that use of credit derivatives does not pose a substantial threat to financial sector stability in the United Kingdom.
- Exposures across major financial institutions appear sufficiently diversified to limit the impact of any shock to the market, while major insurance companies are largely exposed to the "safer" senior tranches.
Key findings
- Use of credit derivatives does not pose a substantial threat to financial sector stability in the United Kingdom.
- Exposures across major financial institutions appear sufficiently diversified to limit the impact of any shock to the market.
- Major insurance companies are largely exposed to the "safer" senior tranches.
Methodology
- Applied a vector autoregression (VAR) model to publicly available market prices to quantify exposures of major U.K. financial groups to credit derivatives.
Policy implications / Stability considerations
- Rapid expansion of CRT instruments in a market with still-limited liquidity could pose problems for financial sector stability in the event of a major negative shock to credit markets.
- Diversification of exposures across major financial institutions appears to mitigate the systemic impact of shocks.
- Concentration of insurance company exposures in senior tranches suggests lower-risk positioning within CRT instruments for that sector.