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Analyzing credit spread changes using explainable artificial intelligence

Author

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  • Heger, Julia
  • Min, Aleksey
  • Zagst, Rudi

Abstract

We compare linear regression, local polynomial regression and selected machine learning methods for modeling credit spread changes. Using partial dependence plots (PDPs) and H-statistic, we find that the outperformance of machine learning models compared to regression ones is mostly attributable to complex non-linearities and not to interactions. The PDPs are additionally used to perform a factor hedging. For the first time, credit spread changes are decomposed by applying SHapley Additive exPlanation (SHAP) values. The proposed framework is applied to US and Euro Area corporate and covered bond credit spread changes of different maturities to quantify the influence of several macroeconomic and financial variables. Despite several commonalities between the decompositions of US and Euro Area credit spread changes, we also observe some differences — particularly related to the impact of certain explanatory variables during crisis periods.

Suggested Citation

  • Heger, Julia & Min, Aleksey & Zagst, Rudi, 2024. "Analyzing credit spread changes using explainable artificial intelligence," International Review of Financial Analysis, Elsevier, vol. 94(C).
    • Handle: RePEc:eee:finana:v:94:y:2024:i:c:s1057521924002473
    DOI: 10.1016/j.irfa.2024.103315
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    More about this item

    Keywords

    Credit spread changes; Random forest; Partial dependence plot; H-statistic; SHAP values; Hedging;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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