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Disastrous Defaults

Author

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  • Gouriéroux Christian
  • Monfort Alain
  • Mouabbi Sarah
  • Renne Jean-Paul

Abstract

We define a disastrous default as the default of a systemic entity. Such an event is expected to have a negative effect on the economy and to be contagious. Bringing macroeconomic structure to a no-arbitrage asset-pricing framework, we exploit prices of disaster-exposed assets (credit and equity derivatives) to extract information on the expected (i) influence of a disastrous default on consumption and (ii) probability of a financial meltdown. We find that the returns of disaster-exposed assets are consistent with a systemic default being followed by a 3% decrease in consumption. The recessionary influence of disastrous defaults implies that financial instruments whose payoffs are exposed to such credit events carry substantial risk premiums. We also produce systemic risk indicators based on the probability of observing a certain number of systemic defaults or a sharp drop of consumption.

Suggested Citation

  • Gouriéroux Christian & Monfort Alain & Mouabbi Sarah & Renne Jean-Paul, 2020. "Disastrous Defaults," Working papers 778, Banque de France.
    • Handle: RePEc:bfr:banfra:778
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    1. Gourieroux, Christian & Jasiak, Joann, 2010. "Inference for Noisy Long Run Component Process," MPRA Paper 98987, University Library of Munich, Germany.
    2. Xing, Kai & Luo, Dan & Liu, Lanlan, 2023. "Macroeconomic conditions, corporate default, and default clustering," Economic Modelling, Elsevier, vol. 118(C).

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    More about this item

    Keywords

    Disaster Risk; Systemic Entities; Default Dependencies; Credit Derivatives; Equilibrium Model.;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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