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Dynamic factor models with macro, frailty and industry effects for US default counts: the credit crisis of 2008

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  • Schwaab, Bernd
  • Koopman, Siem Jan
  • Lucas, André

Abstract

We develop a high-dimensional and partly nonlinear non-Gaussian dynamic factor model for the decomposition of systematic default risk conditions into a set of latent components that correspond with macroeconomic/financial, default-specific (frailty), and industry-specific effects. Discrete default counts together with macroeconomic and financial variables are modeled simultaneously in this framework. In our empirical study based on defaults of U.S. firms, we find that approximately 35 percent of default rate variation is due to systematic and industry factors. Approximately one third of systematic variation is captured by macroeconomic/financial factors. The remainder is captured by frailty (about 40 percent) and industry (about 25 percent) effects. The default-specific effects are particularly relevant before and during times of financial turbulence. For example, we detect a build-up of systematic risk over the period preceding the 2008 credit crisis. JEL Classification: C33, G21

Suggested Citation

  • Schwaab, Bernd & Koopman, Siem Jan & Lucas, André, 2012. "Dynamic factor models with macro, frailty and industry effects for US default counts: the credit crisis of 2008," Working Paper Series 1459, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20121459
    Note: 955417
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    References listed on IDEAS

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    1. Duffie, Darrell & Saita, Leandro & Wang, Ke, 2007. "Multi-period corporate default prediction with stochastic covariates," Journal of Financial Economics, Elsevier, vol. 83(3), pages 635-665, March.
    2. 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.
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    4. Jushan Bai & Serena Ng, 2002. "Determining the Number of Factors in Approximate Factor Models," Econometrica, Econometric Society, vol. 70(1), pages 191-221, January.
    5. Durbin, James & Koopman, Siem Jan, 2012. "Time Series Analysis by State Space Methods," OUP Catalogue, Oxford University Press, edition 2, number 9780199641178.
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    More about this item

    Keywords

    credit portfolio models; Default risk; financial crisis; frailty-correlated defaults; state space methods;
    All these keywords.

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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