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Correlation in corporate defaults: Contagion or conditional independence?

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Author Info

  • Lando, David
  • Nielsen, Mads Stenbo

Abstract

We revisit a method used by Das et al. (2007) (DDKS) who jointly test and reject a specification of firm default intensities and the doubly stochastic assumption in intensity models of default. The method relies on a time change result for counting processes. With an almost identical set of default histories recorded by Moody's in the period from 1982 to 2006, but using a different specification of the default intensity, we cannot reject the tests based on time change used in DDKS. We then note that the method proposed by DDKS is mainly a misspecification test in that it has very limited power in detecting violations of the doubly stochastic assumption. For example, it will not detect contagion which spreads through the explanatory variables "covariates" that determine the default intensities of individual firms. Therefore, we perform a different test using a Hawkes process alternative to see if firm-specific variables are affected by occurrences of defaults, but find no evidence of default contagion.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Intermediation.

Volume (Year): 19 (2010)
Issue (Month): 3 (July)
Pages: 355-372
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Handle: RePEc:eee:jfinin:v:19:y:2010:i:3:p:355-372

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Web page: http://www.elsevier.com/locate/inca/622875

For corrections or technical questions regarding this item, or to correct its listing, contact: (Jeroen Loos).

Related research

Keywords: Default correlation Intensity estimation Hawkes process;

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Cited by:
  1. Carlos Castro Iragorri & Stijn Ferrari, 2010. "Measuring the systemic importance of financial institutions using market information," Financial Stability Review, National Bank of Belgium, vol. 8(1), pages 127-141, June.
  2. Didier Rullière & Diana Dorobantu & Areski Cousin, 2009. "An extension of Davis and Lo's contagion model," Working Papers hal-00374367, HAL.
  3. Alain Monfort ; Jean-Paul Renne, 2010. "Default, Liquidity and Crises : An Econometric Framework," Working Papers 2010-46, Centre de Recherche en Economie et Statistique, revised 2010.
  4. Jacobson, Tor & Kindell, Rikard & Lindé, Jesper & Roszbach, Kasper F., 2008. "Firm Default and Aggregate Fluctuations," CEPR Discussion Papers 7083, C.E.P.R. Discussion Papers.
  5. Yadong Li & Ariye Shater, 2010. "Valuation Bound of Tranche Options," Quantitative Finance Papers 1004.1759, arXiv.org.

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