Grading credit risk with market data
Overview
Since the banking crisis experienced in the Great Recession, much has been written about increases in capital requirements and the associated increased costs in the FX market, especially in the forward and swap prices.
There has also been a fundamental shift in Tier 1 capital requirements and fundamental valuations in the stock and bond markets. Tier 1 capital has increased, but fundamentals have not proportionately improved.
The conclusion reached by Sarin and Summers is that the market is a better indicator of a bank’s risk of insolvency. For their study they collected data and analyzed ten factors:
- Volatility
- Ratio of bank volatility to market volatility
- Implied volatility
- Ratio of bank implied volatility to market volatility
- Option delta
- Beta
- CDS Spread
- Ratio of bank PE ratio to market PE ratio
- Preferred Stock price
- Systemic risk contribution
AtlasFX BankMinder evaluates credit risk for bank selection using four of the above factors: Volatility, Implied Volatility, CDS Spread and the Ratio of Bank PE to Market PE Ratio.
Data is sourced from Bloomberg, LSEG and S&P Capital IQ.
