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Estimating the Probabilities of Default under the Assumption of Unobserved Heterogeneity

In: Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives In 4 Volumes

Author

Listed:
  • Jacob Oded
  • Itzhak Venezia

Abstract

Bond default and rank transition are often modeled as a Markov chain with an absorbing state. However, recent studies have shown that the theory does not match the empirical data. We suggest that this mismatch possibly arises from unobserved heterogeneity and we examine via a numerical example whether increased heterogeneity reduces, as expected, the accuracy of the estimated defaults. The extent to which this reduction is economically significant is also considered. We then suggest a methodology for identifying the heterogeneity parameters and for testing their explanatory power.

Suggested Citation

  • Jacob Oded & Itzhak Venezia, 2024. "Estimating the Probabilities of Default under the Assumption of Unobserved Heterogeneity," World Scientific Book Chapters, in: Cheng Few Lee & Alice C Lee & John C Lee (ed.), Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives In 4 Volumes, chapter 98, pages 3255-3276, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789811269943_0098
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    Keywords

    Financial Accounting; Financial Auditing; Mutual Funds; Hedge Funds; Asset Pricing; Options; Portfolio Analysis; Risk Management; Investment Analysis; Momentum Analysis; Behavior Analysis; Futures; Index Futures; CDCs; Financial Econometrics; Statistics; Financial Derivatives; Financial Accounting;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G1 - Financial Economics - - General Financial Markets
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing
    • G3 - Financial Economics - - Corporate Finance and Governance

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