This file is part of IDEAS, which uses RePEc data


[ Papers | Articles | Software | Books | Chapters | Authors | Institutions | JEL Classification | NEP reports | Search | New papers by email | Author registration | Rankings | Volunteers | FAQ | Blog | Help! ]

Firm Heterogeneity and Credit Risk Diversification

Author info | Abstract | Publisher info | Download info | Related research | Statistics
Author Info
Samuel Hanson
M. Hashem Pesaran ()
Til Schuermann ()

Additional information is available for the following registered author(s):

Abstract

This paper considers a simple model of credit risk and derives the limit distribution of losses under different assumptions regarding the structure of systematic and idiosyncratic risks and the nature of firm heterogeneity. The theoretical results obtained indicate that if firm-specific risk exposures (including their default thresholds) are heterogeneous but come from a common parameter distribution, for sufficiently large portfolios there is no scope for further risk reduction through active credit portfolio management. However, if the firm risk exposures are draws from different parameter distributions, say for different sectors or countries, then further risk reduction is possible, even asymptotically, by changing the portfolio weights. In either case, neglecting parameter heterogeneity can lead to underestimation of expected losses. But, once expected losses are controlled for, neglecting parameter heterogeneity can lead to overestimation of risk, whether measured by unexpected loss or value-at-risk. The theoretical results are confirmed empirically using returns and credit ratings for firms in the U.S. and Japan across seven sectors. Ignoring parameter heterogeneity results in far riskier credit portfolios.

Download Info
To download:

If you experience problems downloading a file, check if you have the proper application to view it first. Information about this may be contained in the File-Format links below. In case of further problems read the IDEAS help file. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.cesifo-group.de/DocCIDL/cesifo1_wp1531.pdf
File Format: application/pdf
File Function:
Download Restriction: no

Publisher Info
Paper provided by CESifo GmbH in its series CESifo Working Paper Series with number CESifo Working Paper No. 1531.

Download reference. The following formats are available: HTML, plain text, BibTeX, RIS (EndNote), ReDIF
Length:
Date of creation: 2005
Date of revision:
Handle: RePEc:ces:ceswps:_1531

Contact details of provider:
Postal: Poschingerstrasse 5, 81679 Munich
Phone: +49 (89) 9224-0
Fax: +49 (89) 985369
Web page: http://www.cesifo.de

For technical questions regarding this item, or to correct its listing, contact: (Julio Saavedra).

Related research
Keywords: risk management correlated defaults heterogeneity diversification portfolio choice

Other versions of this item:

Find related papers by JEL classification:
C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Til Schuermann & Bjoern-Jakob Treutler & Scott M. Weiner & M. Hashem Pesaran, 2003. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
    Other versions:
  2. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January. [Downloadable!] (restricted)
  3. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  4. Lando, David & Skodeberg, Torben M., 2002. "Analyzing rating transitions and rating drift with continuous observations," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 423-444, March. [Downloadable!] (restricted)
  5. Jon Frye, 2000. "Depressing recoveries," Emerging Issues, Federal Reserve Bank of Chicago, issue Oct. [Downloadable!]
  6. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-64, May.
  7. Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July. [Downloadable!] (restricted)
    Other versions:
  8. Jafry, Yusuf & Schuermann, Til, 2004. "Measurement, estimation and comparison of credit migration matrices," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2603-2639, November. [Downloadable!] (restricted)
  9. Lennox, Clive, 1999. "Identifying failing companies: a re-evaluation of the logit, probit and DA approaches," Journal of Economics and Business, Elsevier, vol. 51(4), pages 347-364, July. [Downloadable!] (restricted)
  10. Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May. [Downloadable!] (restricted)
  12. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May. [Downloadable!] (restricted)
    Other versions:
  13. Ke Wang & Darrell Duffie, 2004. "Multi-Period Corporate Failure Prediction With Stochastic Covariates," Econometric Society 2004 Far Eastern Meetings 745, Econometric Society.
  14. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June. [Downloadable!] (restricted)
  15. Darrell Duffie & Ke Wang, 2004. "Multi-Period Corporate Failure Prediction with Stochastic Covariates," NBER Working Papers 10743, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Gordy, Michael B., 2000. "A comparative anatomy of credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 119-149, January. [Downloadable!] (restricted)
  17. Shumway, Tyler, 2001. "Forecasting Bankruptcy More Accurately: A Simple Hazard Model," Journal of Business, University of Chicago Press, vol. 74(1), pages 101-24, January. [Downloadable!] (restricted)
  18. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July. [Downloadable!] (restricted)
  19. Giesecke, Kay & Weber, Stefan, 2004. "Cyclical correlations, credit contagion, and portfolio losses," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3009-3036, December. [Downloadable!] (restricted)
  20. Ke Wang & Darrell Duffie, 2004. "Multi-Period Corporate Failure Prediction With Stochastic Covariates," Econometric Society 2004 Far Eastern Meetings 747, Econometric Society.
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. M. Hashem Pesaran & Til Schuermann & Björn-Jakob Treutler, 2005. "Global Business Cycles and Credit Risk," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
    Other versions:
  2. David K. Musto & Nicholas Souleles, 2005. "A portfolio view of consumer credit," Working Papers 05-25, Federal Reserve Bank of Philadelphia. [Downloadable!]
    Other versions:
  3. cipollini, andrea & missaglia, giuseppe, 2007. "Dynamic Factor analysis of industry sector default rates and implication for Portfolio Credit Risk Modelling," MPRA Paper 3582, University Library of Munich, Germany. [Downloadable!]
Statistics
Access and download statistics

Did you know? You too can volunteer for RePEc, for example by editing a NEP report.

This page was last updated on 2008-9-3.

This information is provided to you by IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut using RePEc data on a server sponsored by the Society for Economic Dynamics.