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Business and Default Cycles for Credit Risk

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  • Siem Jan Koopman

    ()
    (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)

  • Andr� Lucas

    ()
    (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)

Abstract

Various economic theories are available to explain the existence of credit and default cycles. There remains empirical ambiguity, however, as to whether or these cycles coincide. Recent papers_new suggest by their empirical research set-up that they do, or at least that defaults and credit spreads tend to co-move with macro-economic variables. If true, this is important for credit risk management as well as for regulation and systemic risk management. In this paper, we use 1927-1997 U.S. data on real GDP, credit spreads, and business failure rates to shed new light on the empirical evidence. We use a multivariate unobserved components framework to disentangle credit from business cycles. It turns out that cyclical co-movements arise between default rates, but not real GDP. There is, however, a contemporaneous correlation between real GDP and default rates. Regarding the longer term evolution of the series, credit spreads influence default rates and real GDP, but not vice versa. This corroborates some of the empirical findings in the recent literature on the correlation between macrovariables and default rates. It also suggests the use of credit spreads besides or instead of economic growth rates to forecast the dynamics of future default rates.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 03-062/2.

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Date of creation: 29 Jul 2003
Date of revision: 09 Jan 2003
Handle: RePEc:dgr:uvatin:20030062

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Web page: http://www.tinbergen.nl

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Keywords: credit cycles; business cycles; defaults; credit risk; procyclicality; multivariate unobserved component models.;

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  18. Linda Allen & Anthony Saunders, 2003. "A survey of cyclical effects in credit risk measurement model," BIS Working Papers 126, Bank for International Settlements.
  19. Lucas, André & Klaassen, Pieter & Spreij, Peter, 1999. "An analytic approach to credit risk of large corporate bond and loan portfolios," Serie Research Memoranda 0018, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
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  23. Durbin, James & Koopman, Siem Jan, 2001. "Time Series Analysis by State Space Methods," OUP Catalogue, Oxford University Press, number 9780198523543, September.
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