Credit risk of financial institutions

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Finance from the NOVA – School of Business and Economics

Although there is substantial literature on credit risk, studies often do not consider financial institutions. However, considering that several entities are exposed to these institutions, namely through the counterparty role that they play, it is of major relevance the accurate assessment of its credit risk. As such, this study aims at analysing three different models to measure credit risk of financial institutions and conclude which one best predicts credit rating downgrades. The three models studied comprise a credit scoring model; a naïve approach of the Merton (1974) Model; and CDS spreads. The results show that all three models are statistically significant to predict credit rating downgrades of financial institutions, though the latter two prove to better and more timely anticipate downgrades than the credit scoring model.