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Multi-Period Corporate Failure Prediction with Stochastic Covariates

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  • Darrell Duffie
  • Ke Wang
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    Abstract

    We provide maximum likelihood estimators of term structures of conditional probabilities of bankruptcy over relatively long time horizons, incorporating the dynamics of firm-specific and macroeconomic covariates. We find evidence in the U.S. industrial machinery and instruments sector, based on over 28,000 firm-quarters of data spanning 1971 to 2001, of significant dependence of the level and shape of the term structure of conditional future bankruptcy probabilities on a firm's distance to default (a volatility-adjusted measure of leverage) and on U.S. personal income growth, among other covariates.Variation in a firm's distance to default has a greater relative effect on the term structure of future failure hazard rates than does a comparatively sized change in U.S. personal income growth, especially at dates more than a year into the future.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10743.

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    Date of creation: Sep 2004
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    Publication status: published as Duffie, Darrell, Leandro Saita and Ke Wang. "Multi-Period Corporate Default Prediction with Stochastic Covariates,." Journal of Financial Economics 83 (2007): 635-665.
    Handle: RePEc:nbr:nberwo:10743

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    1. Darrell Duffie & Jun Pan & Kenneth Singleton, 1999. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," NBER Working Papers 7105, National Bureau of Economic Research, Inc.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    3. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    4. Philosophov, Leonid V. & Philosophov, Vladimir L., 2002. "Corporate bankruptcy prognosis: An attempt at a combined prediction of the bankruptcy event and time interval of its occurrence," International Review of Financial Analysis, Elsevier, Elsevier, vol. 11(3), pages 375-406.
    5. Bruce D. Meyer, 1988. "Unemployment Insurance And Unemployment Spells," NBER Working Papers 2546, National Bureau of Economic Research, Inc.
    6. Cynthia G. McDonald & Linda M. Van De Gucht, 1999. "High-Yield Bond Default And Call Risks," The Review of Economics and Statistics, MIT Press, vol. 81(3), pages 409-419, August.
    7. Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers, University of California at Berkeley RPF-278, University of California at Berkeley.
    8. Sanjiv Das & Darrell Duffie & Nikunj Kapadia & Leandro Saita, 2006. "Common Failings: How Corporate Defaults are Correlated," NBER Working Papers 11961, National Bureau of Economic Research, Inc.
    9. M. Hashem Pesaran & Til Schuermann & Björn-Jakob Treutler & Scott M. Weiner & April, . "Macroeconomic Dynamics and Credit Risk: A Global Perspective," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 03-13, Wharton School Center for Financial Institutions, University of Pennsylvania.
    10. Fama, Eugene F. & French, Kenneth R., 2004. "New lists: Fundamentals and survival rates," Journal of Financial Economics, Elsevier, Elsevier, vol. 73(2), pages 229-269, August.
    11. David C. Wheelock & Paul W. Wilson, 1995. "Why do banks disappear? The determinants of U.S. bank failures and acquisitions," Working Papers, Federal Reserve Bank of St. Louis 1995-013, Federal Reserve Bank of St. Louis.
    12. Shumway, Tyler, 2001. "Forecasting Bankruptcy More Accurately: A Simple Hazard Model," The Journal of Business, University of Chicago Press, vol. 74(1), pages 101-24, January.
    13. Lando, David & Skodeberg, Torben M., 2002. "Analyzing rating transitions and rating drift with continuous observations," Journal of Banking & Finance, Elsevier, Elsevier, vol. 26(2-3), pages 423-444, March.
    14. Robert F. Engle & Jeffrey R. Russell, 1998. "Autoregressive Conditional Duration: A New Model for Irregularly Spaced Transaction Data," Econometrica, Econometric Society, Econometric Society, vol. 66(5), pages 1127-1162, September.
    15. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, American Finance Association, vol. 49(4), pages 1213-52, September.
    16. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, Econometric Society, vol. 69(3), pages 633-64, May.
    17. Gary Whalen, 1991. "A proportional hazards model of bank failure: an examination of its usefulness as an early warning tool," Economic Review, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, issue Q I, pages 21-31.
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    Cited by:
    1. Rodrigo Alfaro A. & Natalia Gallardo S. & Camilo Vio G., 2010. "Análisis de Derechos Contingentes: Aplicación a Casas Comerciales," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 13(1), pages 73-82, April.
    2. Hanson, Samuel G. & Pesaran, M. Hashem & Schuermann, Til, 2008. "Firm heterogeneity and credit risk diversification," Journal of Empirical Finance, Elsevier, Elsevier, vol. 15(4), pages 583-612, September.
    3. Sorge, Marco & Virolainen, Kimmo, 2006. "A comparative analysis of macro stress-testing methodologies with application to Finland," Journal of Financial Stability, Elsevier, Elsevier, vol. 2(2), pages 113-151, June.
    4. John Y. Campbell & Jens Hilscher & Jan Szilagyi, 2006. "In Search of Distress Risk," NBER Working Papers 12362, National Bureau of Economic Research, Inc.
    5. Rodrigo Alfaro & Natán Golberger, 2013. "The Impact of Persistence in Volatility over the Probability of Default," Working Papers Central Bank of Chile, Central Bank of Chile 689, Central Bank of Chile.
    6. Bartram, Sohnke M. & Brown, Gregory W. & Hund, John E., 2007. "Estimating systemic risk in the international financial system," Journal of Financial Economics, Elsevier, Elsevier, vol. 86(3), pages 835-869, December.
    7. Felipe Zurita, 2008. "La Predicción de la Insolvencia de Empresas Chilenas," Documentos de Trabajo, Instituto de Economia. Pontificia Universidad Católica de Chile. 336, Instituto de Economia. Pontificia Universidad Católica de Chile..

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