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Default, Liquidity, and Crises: an Econometric Framework

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  • Alain Monfort
  • Jean-Paul Renne

Abstract

This article presents a general discrete-time affine framework aimed at jointly modeling yield curves associated with different debtors. The underlying fixed-income securities may differ in terms of credit quality and/or in terms of liquidity. The risk factors follow conditionally Gaussian processes, with drifts and covariance matrices that are subject to regime shifts described by a Markov chain with (historical) non-homogenous transition probabilities. Bond prices are given by quasi-explicit formulas. The tractability of the framework is illustrated by the estimation of a term-structure model of the spreads between U.S. BBB-rated corporate bonds and Treasuries. Alternative applications are proposed, including a sector-contagion model as well as the explicit modeling of credit-rating transitions. Copyright The Author, 2012. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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Article provided by Society for Financial Econometrics in its journal Journal of Financial Econometrics.

Volume (Year): 11 (2013)
Issue (Month): 2 (March)
Pages: 221-262

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Handle: RePEc:oup:jfinec:v:11:y:2013:i:2:p:221-262

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Cited by:
  1. Thomas Laubach, 2010. "Fiscal Policy and Interest Rates: The Role of Sovereign Default Risk," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER International Seminar on Macroeconomics 2010, pages 7-29 National Bureau of Economic Research, Inc.
  2. Alain Monfort & Jean-Paul Renne, 2011. "Credit and Liquidity Risks in Euro-area Sovereign Yield Curves," Working Papers, Centre de Recherche en Economie et Statistique 2011-26, Centre de Recherche en Economie et Statistique.

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