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Nonlinear Modeling of Financial Stability Using Default Probabilities from the Capital Market

Author

Listed:
  • Lucian Liviu ALBU

    (Institute for Economic Forecasting, Romanian Academy)

  • Radu LUPU

    (Institute for Economic Forecasting, Romanian Academy)

  • Adrian Cantemir CĂLIN

    (Institute for Economic Forecasting, Romanian Academy)

  • Iulia LUPU

    ("Victor Slăvescu” Centre for Financial and Monetary Research)

Abstract

Our study relies on a general assumption that prices contain a rational component, which is consistent with the rational expectations theory, and an irrational one, better explained by behavioural economics. We decompose the probabilities of default computed by Bloomberg for the listed Romanian companies by filtering the irrational component with newly proposed gauges. To check for the relevance of the rationality component, we use MiDaS models to study the relation with sectoral GDP gap dynamics for the corresponding companies. Employing regression related methods, we further divide the irrational part of default probabilities into a measure for fear and a measure for habit. After each transformation, we check the connection with the corresponding sectoral GDP gap. Our objective is to investigate the extent to which there is a connection between the macroeconomic expected activity, measured by the sectoral GDP gap and the risk of companies listed at the Bucharest Stock Exchange, quantified by probabilities of default. We embark on this journey with the assumption that the irrational component obfuscates the above-mentioned connections.

Suggested Citation

  • Lucian Liviu ALBU & Radu LUPU & Adrian Cantemir CĂLIN & Iulia LUPU, 2019. "Nonlinear Modeling of Financial Stability Using Default Probabilities from the Capital Market," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(1), pages 19-37, March.
    • Handle: RePEc:rjr:romjef:v::y:2019:i:1:p:19-37
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    References listed on IDEAS

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    Cited by:

    1. Dragos HURU & Ioana MANAFI & Ionut PANDELICA & Marilena Carmen UZLAU, 2022. "Nonlinear Dependencies between Green Bonds and General Financial Market Indices," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(4), pages 169-181, December.
    2. Radu LUPU & Iulia LUPU & Tanase STAMULE & Mihai ROMAN, 2022. "Entropy as Leading Indicator for Extreme Systemic Risk Events," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(4), pages 58-73, December.

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    More about this item

    Keywords

    probabilities of default; fear; loss aversion; asymmetric volatility; day-of-the-week-effect; MiDaS regressions;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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