This paper empirically investigates the determinants of credit spreads for Japanese mega-banks with emphasis on comparing subordinated CDS spreads with the subordinated bond spreads from the viewpoint of price discovery in both credit markets. The main findings are summarized as follows. First, subordinated CDS and subordinated bond spreads are significantly cointegrated for most banks, and price discovery measures suggest that the CDS spread plays a more dominant role in price discovery than the bond spread. Second, although both CDS and bond spreads significantly react to the Japanese sovereign CDS spread, only the CDS spread reacts significantly to other financial market variables including its own volatility and equity return. Third, both spreads are responsive to the changes in fundamental accounting variables such as the capital-asset ratio and the nonperforming loan ratio. These accounting variables are likely to constitute common factors that are behind the cointegration relationship. Last, significant volatility spillovers are detected from the CDS to bond spreads. This result implies that new information flows more in this direction.
Keywords: Subordinated Bond; Credit Default Swap; Japanese Banks; Price Discovery; Volatility Spillover; Bivariate GARCH
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.