The key inputs behind smarter credit risk scoring
The combined predictive power of CDS spreads, equity volatility and credit rating
BankMinder scores leading indicators of bank default and incorporates that into your pre-trade decision automation. You only have to provide the weighting for credit risk assessment and BankMinder will do the rest for you. AtlasFX has based its inputs, and the focus on CDS spreads, on extensive market research over the past 15 years.
The credit default market has become the primary leading indicator of bank distress due to its liquidity and performance during the 2008 banking crisis. Its predictive power exceeds that of equity market factors and regulatory accounting measures. However, best practice includes other factors which are also indicative of bank soundness.
BankMinder also calculates equity volatility, both realized and implied, to add value to our rating factor. Lastly, a numerical score for credit rating completes the overall scoring for credit risk:
Inputs
- CDS Spread (bps): Preferred primary credit market signal (source: Markit / ICE / Bloomberg).
- Equity Historical Volatility Ratio: (σbank_hist / σS&P500_hist) — relative realized volatility (e.g., 90-day).
- Equity Implied Volatility Ratio: (IVbank / VIXequiv or IVmarket) — forward-looking stress.
- Credit Rating Score: Numeric mapping of agency rating to risk (higher numeric → worse). Example mapping:
- AAA = 1
- AA = 2
- A = 3
- BBB = 4
- BB = 5
- B = 6
- <B = 7
(Or invert and scale if preferred.)
Supporting research
1 Avino, D. E., Conlon, T., & Cotter, J. — “Credit Default Swaps as Indicators of Bank Financial Distress” (Journal of International Money and Finance, 2019).
2 Chiaramonte, Laura, and Barbara Casu. “Are CDS Spreads a Good Proxy of Bank Risk? Evidence from the Financial Crisis.” Working Paper, Cass Business School / Università Cattolica del Sacro Cuore, 2010. DOI: 10.1080/1351847X.2011.636832. European Journal of Finance, Vol. 19, No. 9, pp. 861–887.
