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From Fault Tree to Credit Risk Assessment: An Empirical Attempt

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  • Hayette Gatfaoui

    (The University of Paris 1 - Panthéon-Sorbonne)

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    Abstract

    Since 80’, fault tree theory has known a great development in industrial systems’ sector. Its first goal is to estimate and model the probability and events combination which could lead a given system to failure. Later static and dynamic studies arise such as Dugan, Venkataraman & Gulati (1997), Gulati & Dugan (1997) and Ngom et al. (1999) for example. Improvements are also proposed by Anand & Somani (1998)[REF], Zhu et al. (2001)[REF] and Reory & Andrews (2003)[REF] among others. Since credit risk valuation attempts to quantify firms’ default risk, we propose to apply one alternative approach of fault tree, or equivalently, reliability study to assess firms’ default risk. We set a very simple framework and use French firms’ bankruptcy statistics to quantify default probabilities. From these empirical default probabilities and under the assumption that the lifetime process follows an exponential law with a constant parameter, we estimate this constant parameter for French sectors. Each parameter’s estimation corresponds to the related hazard rate over the time horizon under consideration. Checking for the consistency of our constant parameter’s assumption, we compute the monthly implied parameters related to our exponential law setting. Results show a time varying behavior for those parameters. Indeed, each exponential law’s parameter is a convex decreasing function of time. Whatever, such an approach may be useful to give a statistical benchmark for common credit risk models’ improvement.

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    File URL: http://128.118.178.162/eps/ri/papers/0308/0308003.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Risk and Insurance with number 0308003.

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    Length: 27 pages
    Date of creation: 25 Aug 2003
    Date of revision:
    Handle: RePEc:wpa:wuwpri:0308003

    Note: Type of Document - Acrobat PDF; prepared on PC; to print on HP/PostScript; pages: 27 ; figures: included. This paper is under submission for the Journal of Risk.
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    Web page: http://128.118.178.162

    Related research

    Keywords: credit risk default probability failure rate fault tree reliability survival;

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    References

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    1. 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.
    2. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
    3. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
    4. Barlow, Richard E. & Proschan, Frank, 1975. "Importance of system components and fault tree events," Stochastic Processes and their Applications, Elsevier, vol. 3(2), pages 153-173, April.
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    Cited by:
    1. Hayette Gatfaoui, 2004. "From Fault Tree to Credit Risk Assessment: A Case Study," EERI Research Paper Series EERI_RP_2004_05, Economics and Econometrics Research Institute (EERI), Brussels.
    2. Hayette GATFAOUI, 2005. "From Fault Tree to Credit Risk Assessment: A Case Study," Econometrics 0509002, EconWPA.

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