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Frailty Correlated Default

Author

Listed:
  • DARRELL DUFFIE
  • ANDREAS ECKNER
  • GUILLAUME HOREL
  • LEANDRO SAITA

Abstract

The probability of extreme default losses on portfolios of U.S. corporate debt is much greater than would be estimated under the standard assumption that default correlation arises only from exposure to observable risk factors. At the high confidence levels at which bank loan portfolio and collateralized debt obligation (CDO) default losses are typically measured for economic capital and rating purposes, conventionally based loss estimates are downward biased by a full order of magnitude on test portfolios. Our estimates are based on U.S. public nonfinancial firms between 1979 and 2004. We find strong evidence for the presence of common latent factors, even when controlling for observable factors that provide the most accurate available model of firm‐by‐firm default probabilities.

Suggested Citation

  • Darrell Duffie & Andreas Eckner & Guillaume Horel & Leandro Saita, 2009. "Frailty Correlated Default," Journal of Finance, American Finance Association, vol. 64(5), pages 2089-2123, October.
    • Handle: RePEc:bla:jfinan:v:64:y:2009:i:5:p:2089-2123
    DOI: 10.1111/j.1540-6261.2009.01495.x
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    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C41 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Duration Analysis; Optimal Timing Strategies
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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