Credit Risk and the Finnish Economy
The significance of credit risk models has increased with the introduction of the New Basel Accord, known as Basel II. The aim of this study is to examine default rate modeling. This paper follows two possible approaches to macro credit risk modeling, empirical models and a latent factor model based on Merton. We employ data over the time period from 1988 to 2003 for the Finnish economy, including time series of bankruptcy, numbers of firms and industry-specific data. Linear vector autoregressive models are used in the case of a dynamic empirical model. We examine how significant macroeconomic indicators determine the default rate in the whole economy and in industry-specific sectors. Since these models cannot provide microeconomic foundations, we employ a model with one latent factor, although multi-factor models are also considered. This estimation helps us to understand the relationships between credit risk and macroeconomic indicators. Both models can be used for default rate prediction or stres s testing by central authorities.
Volume (Year): 1 (2007)
Issue (Month): 3 (November)
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References listed on IDEAS
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- Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.).
- André Lucas & Siem Jan Koopman, 2005. "Business and default cycles for credit risk," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(2), pages 311-323.
- Giuseppe Marotta & Chiara Pederzoli & Costanza Torricelli, 2005. "Forward-looking estimation of default probabilities with Italian data," Heterogeneity and monetary policy 0504, Universita di Modena e Reggio Emilia, Dipartimento di Economia Politica.
- Gertjan W. Vlieghe, 2001. "Indicators of fragility in the UK corporate sector," Bank of England working papers 146, Bank of England.
- Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
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