Bank risk is the likelihood that a government goes bankrupt and the amount the investor loses if it happens. Credit-risky securities include bank bonds. Credit default swaps are widely used derivatives used in credit risk management to describe market perceptions of credit risk for a specific financial institute. Credit default swaps (CDS) are derivatives contracts which by construction aim at quantifying the risk of default of a counterparty. Therefore, CDS written for banks are early signals to monitor and detect elevated credit risk conditions for these banks and as a consequence for the global financial system.
MacroVar calculates for each of the banks credit default swaps the average of the six month and twelve month z-scores. Extreme values of z-scores greater than two indicate elevated credit risk conditions and vice-versa. MacroVar bank risk index is the average of z-scores of the tweleve credit default swaps tracked.