RT Journal Article
SR Electronic
T1 Implicit Government Guarantee and the CDS Spreads
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 25
OP 37
DO 10.3905/jfi.2015.25.2.025
VO 25
IS 2
A1 Natalia Beliaeva
A1 Shahriar Khaksari
A1 Georges Tsafack
YR 2015
UL https://pm-research.com/content/25/2/25.abstract
AB It is commonly agreed that the government is more likely to step in and rescue some troubled companies labeled as “too big to fail” or “too interconnected to fail.” Since there is no formal contract between these companies and the government, this potential intervention is referred to as an implicit government guarantee. We propose a new approach of assessing and estimating the implicit government guarantee and analyze whether it is reflected in the CDS spreads. We define the implicit government guarantee for a given company as the probability that the government will bail it out in case of a default. Although the company’s size affects the likelihood of government intervention, we find that financial industry membership is a more important factor. Furthermore, we find that the implicit government guarantee is priced into the CDS spreads. The government guarantee for large companies reduces the CDS spread by 16.11 bps and for small companies only by 3.73 bps. Similarly, for the financial industry, we find that the government guarantee reduces the CDS spread by 76.29 bps and for the nonfinancial industry only by 7.50 bps.TOPICS: Financial crises and financial market history, credit default swaps