Credit risk and interconnectedness: an asset pricing study

Abstract

This study lay the foundation for merging two parallelly studied strains of academic literature asset risk factors and systemic banking risk, in order to create a measure incorporating credit risk in the banking sector and banking sector interconnectedness. The theoretical work accumulates to a proposed two factor model including a novel measure of interconnected credit risk and the traditional market factor. Despite the unsatisfactory statistical results, the theoretical foundation remains robust and the literature combining these twin brothers in the academic field of research is by a large unexplored. Thus, this paper’s theoretical development is significant.