Identifying Contagion in a Banking Network

This paper studies the impact of trading profits and losses on bank counter-party borrowing costs using data from a derivatives trade depositary. We use the network of credit default swap CDS) transactions between banks to identify bank CDS returns attributable to counter-party losses. Any bank's exposure to corporate default increases whenever counter-parties from whom it has purchased default protection themselves experience losses. In line with this statement, we document an increase in the own CDS spread of such a bank. We find no such effect from losses of non-counter-parties, nor from counter-parties who have bought protection from, rather than sold protection to, the bank. We also find that the effect on bank CDS returns through this counter-party loss channel is large relative to the direct effect on a bank's CDS returns from its own trading losses