CDS spreads are often seen as the ’leading’ market based, default risk measure. There is no
popular alternative to CDS spreads except perhaps for the distance-to-default (D2D) measure
based on Merton (1974), which comes very close to it. In this paper, we investigate the correlation
and short-term dynamics between these two measures for large European banks with a data panel
spanning from 1/2006 to 12/2013. The analysis makes use of conventional Granger causality test
statistics for individual banks and for the whole panel data. As regards the results, we found that
the lead-lag relationship between these highly related variables varies over time, over different
banks, and over economic regimes. The lead of D2D is signifi cantly stronger for banks that are
smaller relative to the other banks in the sample, banks in problem countries (PIIGS), after global
fi nancial crises, during market turmoil, and for banks with poor credit quality indicated by a high
CDS spread. These results and the fact that D2D can be calculated for every bank quoted on the
stock exchange suggests that D2D is a promising alternative to the CDS spread in default risk
assessment of banks.