Reproduction permitted only if source is stated. ISBN Non-technical summary Research questionThe identification and quantification of the systemic component of financial risk require an in-depth understanding of the channels through which shocks can spread and amplify, thereby jeopardizing the stability of a financial system. Our understanding of these links as a whole is, however, hampered by the absent comprehension of the key determinants of financial institutions' interconnections. This has been due to the lack of comprehensive datasets on a from-whom-to-whom basis that are sufficient for analyses of this kind. Therefore, a number of recent studies have suggested network estimation techniques based on market information to overcome this hurdle. In this paper, we examine the relationship between market-based measures of credit risk interconnectedness and actual common exposures of banks through their funding and securities holdings. ContributionWe use CDS prices to measure market-implied interconnectedness between banks employing a correlation-based approach and use a unique proprietary dataset for the period 2006-2013 to evaluate how much market information-based measures capture actual balance sheet linkages and risks associated with banks' funding, security investment, and credit provision behavior. ResultsTwo main results emerge from our analysis. First, we find that our market-based interconnectedness measure strongly reflects the information on banks' exposure to the wholesale funding market and assets associated with securities investments and credit supply. Second, we show that the relation between our market-based interconnectedness measure and the balance sheet positions exhibits asymmetries both over time and cross-sectionally. For instance, we find that interbank lending is a relevant driver of our measure during crisis times as other sources of financing become hard to obtain. And, bank pairs with higher exposures to the troubled security classes show up as more interconnected. On the contrary, commonality in securities investments related to crisis-unaffected security classes does not induce higher dependency. These results show that market information-based measures of interdependence can serve well as a risk monitoring tool in the absence of disaggregated highfrequency bank fundamental data. Abstract We analyze the relation between market-based credit risk interconnectedness among banks during the crisis and the associated balance sheet linkages via funding and securities holdings. For identification, we use a proprietary dataset that has the funding positions of banks at the bank-to-bank level for 2006-13 in conjunction with investments of banks at the security level and the credit register from Germany. We find asymmetries both cross-sectionally and over time: when banks face di culties to raise funding, the interbank lending a↵ects market-based bank interconnectedness. Moreover, banks with investments in securities related to troubled classes have a higher credit risk interconnectedness. ...

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Abstract:We examine contagion from a number of financial systems to the German financial system using the information content of CDS prices in a GARCH model. After controlling for common factors which may cause comovement in security prices, we find evidence for contagion from the US and European financial systems. Our results additionally confirm that the set up of the financial rescue scheme in Germany partially shielded German banks but not insurance companies from contagion. Overall, our results suggest that contagion from dealer banks have the most prominent effect on the German financial system. While dealer banks impact on German banks and insurance companies in a similar way, a deterioration in the CDS spreads of dealer banks has a particularly pronounced effect on German dealer banks. Keywords:Systemic Risk, CDS Spreads, Contagion, OTC Dealer JEL-Classification: G14, G21, G28 Non-technical summaryThe global financial crises has led to a marked rise in the awareness of the importance of systemic risk. More specifically, the crisis has demonstrated that systemic events can rapidly spill over across borders and to markets, gathering strength and augmenting systemic risk. The vulnerability of financial institutions to contagious effects has placed this issue on top of the agenda of financial stability regulation.In this paper, we examine contagion effects emanating from the financial systems of the US, Europe, Asia-Pacific region and emerging markets to the German financial system using the information content of CDS prices. The structure of OTC markets makes this market and the dealer banks particularly vulnerable to contagion. This is largely due to the high concentration of trading among a few dealers and to the opaqueness of the market. For this reason, we specifically examine the strength of contagion from dealer banks to the German financial system, distinguishing between banks and insurance companies. In addition we explore the magnitude of contagion over time. The relevance of the dynamic nature of contagion was demonstrated during the financial crisis, which started in the US housing market but peaked when a number of individual institutions became distressed. We thus investigate changes in the strength of these financial systems' interdependence. To achieve this we consider, inter alia, the impact of the default of Lehman Brothers and the financial stabilization scheme set up in Germany. To address all these objectives, we use weighted CDS spread indices for each financial system. Our reliance on broad indices allows us to obtain a comprehensive view of the risk to the German financial system. Our findings suggest that there are strong contagious effects from the US and Europe and no effects from the Asia-Pacific region and emerging markets on the the German financial system. While the magnitude of contagion from the US and Europe to the German financial system is comparable, contagion from the US only affects the level of risk in the German financial system, while contagion from the European fina...

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