Abstract
This paper uses a structural time series methodology to test the notion of interconnectedness between the UK and the US credit markets. The empirical tests utilise data on premium for the Banking sector credit default swaps (CDS) and covers the recent period of financial turmoil. The methodology based on Kalman filter is robust in the presence of limited convergence. The long-term steady state convergence in CDS premium is clearly noticeable between these two markets from the results. This observation lends support for the coordinated regulatory policy initiatives to deal with the crisis and offer suggestions for sound operations of the international financial systems.
Highlights
The world has experienced financial turmoil of unprecedented proportions over the last few years
Given the role played by the financial institutions and the consequences of the financial crisis across the advanced economies, this paper is motivated to examine the dynamic behaviour of the Banking sector indices for the credit default swaps (CDS) (Credit Default Swaps) spread for two OECD economies. That both the US and the UK have large banking sector and their relative importance to the respective economies, we examine whether the perceived riskiness of this sector was converging over time
We focus on the CDS market data to analyse convergence in the two OECD credit markets
Summary
The world has experienced financial turmoil of unprecedented proportions over the last few years. It was preceded by a long period of abundant liquidity, rising asset prices and low interest rates. In the context of international financial integration and innovation this led to the build-up of global macroeconomic imbalances as well as a global “search-for-yield” and general underpricing of risk by investors. Regulators in some cases facilitated, and in other cases failed to respond to the build-up in imbalances. The plentiful liquidity induced a rapid expansion of credit in many developed and emerging countries. Mortgage finance was one of the high growth areas, both in the US and elsewhere, and contributed to a bubble in global real estate prices
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