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Credit cycles and macro fundamentals

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  • Koopman, Siem Jan
  • Kräussl, Roman
  • Lucas, André

Abstract

We study the relation between the credit cycle and macro economic fundamentals in an intensity based framework. Using rating transition and default data of U.S. corporates from Standard and Poor’s over the period 1980–2005 we directly estimate the credit cycle from the micro rating data. We relate this cycle to the business cycle, bank lending conditions, and financial market variables. In line with earlier studies, these variables appear to explain part of the credit cycle. As our main contribution, we test for the correct dynamic specification of these models. In all cases, the hypothesis of correct dynamic specification is strongly rejected. Moreover, accounting for dynamic mis-specification, many of the variables thought to explain the credit cycle, turn out to be insignificant. The main exceptions are GDP growth, and to some extent stock returns and stock return volatilities. Their economic significance appears low, however. This raises the puzzle of what macro-economic fundamentals explain default and rating dynamics --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2006/33.

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Date of creation: 2006
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Handle: RePEc:zbw:cfswop:200633

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Keywords: Credit Cycles; Business Cycles; Bank Lending Conditions; Unobserved Component Models; Intensity Models; Monte Carlo Likelihood;

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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. André Lucas & Pieter Klaassen, 2003. "Discrete versus Continuous State Switching Models for Portfolio Credit Risk," Tinbergen Institute Discussion Papers 03-075/2, Tinbergen Institute, revised 30 Sep 2003.
  3. Fama, Eugene F., 1986. "Term premiums and default premiums in money markets," Journal of Financial Economics, Elsevier, vol. 17(1), pages 175-196, September.
  4. James H. Stock & Mark W. Watson, 1989. "New Indexes of Coincident and Leading Economic Indicators," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 351-409 National Bureau of Economic Research, Inc.
  5. Roman Kraeussl, 2003. "Sovereign Credit Ratings and Their Impact on Recent Financial Crises," Working Papers 0313, University of Crete, Department of Economics.
  6. Darrel Duffie & Leandro Saita & Ke Wang, 2005. "Multi-Period Corporate Default Prediction With Stochastic Covariates," CIRJE F-Series CIRJE-F-373, CIRJE, Faculty of Economics, University of Tokyo.
  7. Pamela Nickell & William Perraudin & Simone Varotto, 2001. "Stability of ratings transitions," Bank of England working papers 133, Bank of England.
  8. Anil Bangia & Francis X. Diebold & Til Schuermann, 2000. "Ratings Migration and the Business Cycle, With Application to Credit Portfolio Stress Testing," Center for Financial Institutions Working Papers 00-26, Wharton School Center for Financial Institutions, University of Pennsylvania.
  9. Carling, Kenneth & Jacobson, Tor & Linde, Jesper & Roszbach, Kasper, 2007. "Corporate credit risk modeling and the macroeconomy," Journal of Banking & Finance, Elsevier, vol. 31(3), pages 845-868, March.
  10. Siem Jan Koopman & Andr� Lucas, 2003. "Business and Default Cycles for Credit Risk," Tinbergen Institute Discussion Papers 03-062/2, Tinbergen Institute, revised 09 Jan 2003.
  11. Carling, Kenneth & Jacobson, Tor & Lindé, Jesper & Roszbach, Kasper, 2002. "Capital Charges under Basel II: Corporate Credit Risk Modelling and the Macro Economy," Working Paper Series 142, Sveriges Riksbank (Central Bank of Sweden).
  12. 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.
  13. Philipp J. Schönbucher, 2000. "Factor Models for Portofolio Credit Risk," Bonn Econ Discussion Papers bgse16_2001, University of Bonn, Germany.
  14. Siem Jan Koopman & André Lucas & André Monteiro, 2005. "The Multi-State Latent Factor Intensity Model for Credit Rating Transitions," Tinbergen Institute Discussion Papers 05-071/4, Tinbergen Institute, revised 04 Jul 2005.
  15. Ferri, Giovanni & Liu, Li-Gang & Majnoni, Giovanni, 2001. "The role of rating agency assessments in less developed countries: Impact of the proposed Basel guidelines," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 115-148, January.
  16. Lucas, Andre & Klaassen, Pieter & Spreij, Peter & Straetmans, Stefan, 2001. "An analytic approach to credit risk of large corporate bond and loan portfolios," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1635-1664, September.
  17. Siem Jan Koopman & Andr� Lucas & Bernd Schwaab, 2008. "Forecasting Cross-Sections of Frailty-Correlated Default," Tinbergen Institute Discussion Papers 08-029/4, Tinbergen Institute.
  18. 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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