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A reduced form model of default spreads with Markov-switching macroeconomic factors

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  • Dionne, Georges
  • Gauthier, Geneviève
  • Hammami, Khemais
  • Maurice, Mathieu
  • Simonato, Jean-Guy

Abstract

We examine the ability of observed macroeconomic factors and the possibility of changes in regime to explain the proportion of yield spreads caused by the risk of default in the context of a reduced form model. For this purpose, we extend the Markov-switching risk-free term structure model of Bansal and Zhou (2002) to the corporate bond setting and develop recursive formulas for default probabilities, risk-free and risky zero-coupon bond yields as well as credit default swap premia. The model is calibrated with consumption, inflation, risk-free yields and default data for Aa, A and Baa bonds from the 1987 to 2008 period. We find that our macroeconomic factors are linked with two out of three sharp increases in the spreads during this sample period, indicating that the spread variations can be related to macroeconomic undiversifiable risk.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 35 (2011)
Issue (Month): 8 (August)
Pages: 1984-2000

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Handle: RePEc:eee:jbfina:v:35:y:2011:i:8:p:1984-2000

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Keywords: Credit spread Default spread Markov-switching Macroeconomic factors Reduced form model of default Random subjective discount factor Credit default swap;

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Cited by:
  1. Bazán, Walter, 2011. "No-linealidades y asimetrías en el crédito peruano," Working Papers 2011-015, Banco Central de Reserva del Perú.
  2. Timothée Papin & Gabriel Turinici, 2012. "Prepayment option of a perpetual corporate loan: the impact of the funding costs," Working Papers hal-00768571, HAL.
  3. Georges Dionne & Olfa Maalaoui Chun, 2013. "Default and liquidity regimes in the bond market during the 2002-2012 period," Canadian Journal of Economics, Canadian Economics Association, vol. 46(4), pages 1160-1195, November.
  4. Chevallier, Julien, 2011. "Evaluating the carbon-macroeconomy relationship: Evidence from threshold vector error-correction and Markov-switching VAR models," Economics Papers from University Paris Dauphine 123456789/6970, Paris Dauphine University.
  5. Chevallier, Julien, 2012. "Global imbalances, cross-market linkages, and the financial crisis : a multivariate Markov-Switching analysis," Economics Papers from University Paris Dauphine 123456789/8773, Paris Dauphine University.
  6. repec:hal:cesptp:halshs-00658540 is not listed on IDEAS
  7. Badye Essid & Tolga Cenesizoglu, 2010. "The Effect of Monetary Policy on Credit Spreads," 2010 Meeting Papers 1139, Society for Economic Dynamics.
  8. Timothée Papin & Gabriel Turinici, 2014. "Prepayment option of a perpetual corporate loan: the impact of the funding costs," Post-Print hal-00768571, HAL.
  9. Chevallier, Julien, 2011. "A model of carbon price interactions with macroeconomic and energy dynamics," Economics Papers from University Paris Dauphine 123456789/6969, Paris Dauphine University.
  10. repec:hal:journl:halshs-00658540 is not listed on IDEAS
  11. Georges Dionne & Pascal François & Olfa Maalaoui Chun, 2009. "Detecting Regime Shifts in Corporate Credit Spreads," Cahiers de recherche 0929, CIRPEE.

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