Nordic Banks - Credit Risk and Risk Linkages

Abstract: The recent global financial crisis has once again shown how fragile the financial system is. This essay investigates the credit risk in the Nordic banking sector by measuring the probability of default of the six major Nordic banks. This is done by using the Merton (1974) model which utilizes stock prices as well as balance sheet data. The results are compared with an approach first suggested by Hall and Miles (1990) which relies solely on stock market prices. In order to highlight the risk of a highly concentrated banking sector, the essay also investigates the spillover effects from one bank to another. The essay follows the example of Adrian and Brunnermeier (2011) that have developed the commonly used VaR into CoVaR, a risk measure that takes systemic risk into account.