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Interdependencies between Expected Default Frequency and the Macro Economy

  • Per Asberg Sommar

    (Financial Stability Department, Sveriges Riksbank)

  • Hovick Shahnazarian

    (Financial Stability Department, Sveriges Riksbank)

Registered author(s):

    We use a vector error-correction model to study interdependencies between the aggregate expected default frequency (EDF) and the macroeconomic development. The model is used to forecast the median EDF. Evaluations of the model show that it yields low forecast errors and that the interest rate has the strongest impact on expected default frequency. Forecasts indicate that a lower short-term interest rate reduces the EDF and, in turn, risk premiums. This reduces the marginal cost for corporate investments and household consumption and stimulates growth through these two components of aggregate demand. At the same time, it imposes a downward pressure on the product prices of firms and thereby on inflation.

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    Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

    Volume (Year): 5 (2009)
    Issue (Month): 3 (September)
    Pages: 83-110

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    Handle: RePEc:ijc:ijcjou:y:2009:q:3:a:3
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    1. Jorge A. Chan-Lau, 2006. "Fundamentals-Based Estimation of Default Probabilities: A Survey," IMF Working Papers 06/149, International Monetary Fund.
    2. Jacobson, Tor & Linde, Jesper & Roszbach, Kasper, 2005. "Exploring interactions between real activity and the financial stance," Journal of Financial Stability, Elsevier, vol. 1(3), pages 308-341, April.
    3. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    4. 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.
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    6. Til Schuermann & Björn-Jakob Treutler & Scott M. Weiner & M. Hashem Pesaran, 2003. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," CESifo Working Paper Series 995, CESifo Group Munich.
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