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Dynamic Factor Models With Macro, Frailty, and Industry Effects for U.S. Default Counts: The Credit Crisis of 2008

  • Siem Jan Koopman
  • André Lucas
  • Bernd Schwaab

We develop a high-dimensional, nonlinear, and non-Gaussian dynamic factor model for the decomposition of systematic default risk conditions into latent components for (1) macroeconomic/financial risk, (2) autonomous default dynamics (frailty), and (3) industry-specific effects. We analyze discrete U.S. corporate default counts together with macroeconomic and financial variables in one unifying framework. We find that approximately 35% of default rate variation is due to systematic and industry factors. Approximately one-third of this systematic variation is captured by the macroeconomic and financial factors. The remainder is captured by frailty (40%) and industry (25%) effects. The default-specific effects are particularly relevant before and during times of financial turbulence. We detect a build-up of systematic risk over the period preceding the 2008 credit crisis. This article has online supplementary material.

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File URL: http://hdl.handle.net/10.1080/07350015.2012.700859
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Article provided by Taylor & Francis Journals in its journal Journal of Business & Economic Statistics.

Volume (Year): 30 (2012)
Issue (Month): 4 (May)
Pages: 521-532

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Handle: RePEc:taf:jnlbes:v:30:y:2012:i:4:p:521-532
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  1. Darrell Duffie & Leandro Siata & Ke Wang, 2006. "Multi-Period Corporate Default Prediction With Stochastic Covariates," NBER Working Papers 11962, National Bureau of Economic Research, Inc.
  2. Jushan Bai & Serena Ng, 2000. "Determining the Number of Factors in Approximate Factor Models," Econometric Society World Congress 2000 Contributed Papers 1504, Econometric Society.
  3. Durbin, James & Koopman, Siem Jan, 2001. "Time Series Analysis by State Space Methods," OUP Catalogue, Oxford University Press, number 9780198523543, March.
  4. Sanjiv R. Das & Darrell Duffie & Nikunj Kapadia & Leandro Saita, 2007. "Common Failings: How Corporate Defaults Are Correlated," Journal of Finance, American Finance Association, vol. 62(1), pages 93-117, 02.
  5. Darrell DUFFIE & Andreas ECKNER & Guillaume HOREL & Leandro SAITA, . "Frailty Correlated Default," Swiss Finance Institute Research Paper Series 08-44, Swiss Finance Institute.
  6. Lucia Alessi & Matteo Barigozzi & Marco Capasso, 2007. "A Robust Criterion for Determining the Number of Static Factors in Approximate Factor Models," LEM Papers Series 2007/19, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
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