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Estimating and Forecasting Default Risk: Evidence from Jamaica

Author

Listed:
  • Andrene Senior

    (Bank of Jamaica)

  • Sherene A. Bailey

    (Bank of Jamaica)

Abstract

This paper employs the generalized method of moments estimation technique to evaluate the impact of macroeconomic factors on bank default risk for listed Jamaican banks and securities dealers over the period December 2004 to June 2016. Default risk is captured by a distance to default measure which is computed using a Merton type, option-based model. This indicator accurately tracks the default experience of listed Jamaican banks and securities dealers over important dates throughout the sample period. The estimation results of the model revealed that gross domestic product growth, inflation, unemployment rate, growth in domestic private sector credit as well as the real effective exchange rate have a statistically significant impact on the performance of the distance to default measure. As such, the econometric findings validate the sensitivity of the fragility measure to the variability of key macroeconomic variables. The model was also utilized to forecast the distance to default measure six-quarters ahead, as this will aid in the formulation of policy to mitigate systemic risks in the financial sector. The forecast results showed less volatility and lower overall default risk for Jamaican banks and securities dealers due to the projected improvement in various macroeconomic indicators.

Suggested Citation

  • Andrene Senior & Sherene A. Bailey, 2017. "Estimating and Forecasting Default Risk: Evidence from Jamaica," Monetaria, Centro de Estudios Monetarios Latinoamericanos, vol. 0(1), pages 133-162, January-J.
  • Handle: RePEc:cml:moneta:v:xxxix:y:2017:i:1:p:133-162
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    References listed on IDEAS

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    1. Manuel Arellano & Stephen Bond, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Oxford University Press, vol. 58(2), pages 277-297.
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    Keywords

    default risk; forecasting; macroeconomic factors;

    JEL classification:

    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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