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Correlations and business cycles of credit risk: Evidence from bankruptcies in Germany

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Author Info
Rösch, Daniel
Abstract

A major topic in empirical finance is correlation of default risk. Correlations are the main drivers for credit risk on a portfolio basis and for banks’ capital requirements under the New Basel Accord. However, empirical evidence on the magnitude of correlations is rather scarce, mainly due to data limitations. Using a large database of bankruptcies in Germany we estimate correlations using a simple version of the Basel II factor model. Then we extend the model to an approach with observable risk factors and suggest that this model with default probabilities depending on the state of the economy may be more adequate. Empirical evidence on proxies for the credit cycles is presented for German industry sectors. We find that much of the co-movements can be explained by our variables. Finally, we discuss some implications for forecasts of distributions of potential future defaults of a bank’s portfolio.

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Paper provided by University of Regensburg, Department of Economics in its series Regensburger Diskussionsbeiträge zur Wirtschaftswissenschaft with number 380.

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Date of creation: 16 Mar 2005
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Handle: RePEc:bay:rdwiwi:483

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Related research
Keywords: Credit risk dependencies; credit risk models; Kreditrisiko;

Find related papers by JEL classification:
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
G20 - Financial Economics - - Financial Institutions and Services - - - General
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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