This paper revisits the credit spread puzzle in bank CDS spreads from the perspective of information contagion. The puzzle, rst detected in corporate bonds, consists of two stylized facts: Structural determinants of credit risk not only have low explanatory power but also fail to capture a systematic common factor in the residuals (Collin-Dufresne et al., 2001). For the case of banks, we hypothesize that the puzzle exists because of omitted network effects. We therefore extend the structural models to account for information spillovers based on bank business model similarities. To capture this channel, we propose and construct a new intuitive measure for portfolio overlap using the complete asset holdings of the largest banks in the Eurozone. Incorporating the network information into the structural model for bank credit spreads increases explanatory power and explains the systemic common factor in the residuals.
Keywords: Information contagion, credit spread puzzle, bank business model similarities, portfolio overlap measure, dynamic network effects model.
JEL classications: G01, G21, C32, C33, C38.