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Measures of Aggregate Credit Conditions and Their Potential Use by Central Banks

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  • Alejandro García
  • Andrei Prokopiw

Abstract

Understanding the nature of credit risk has important implications for financial stability. Since authorities—notably, central banks—focus on risks that have systemic implications, it is crucial to develop ways to measure these risks. The difficulty lies in finding reliable measures of aggregate credit risk in the economy, as opposed to firmlevel credit risk. In this paper, the authors examine two models recently developed for this purpose: a reduced-form model applied to credit default swap index tranches, and a structural model applied to the spread on U.S. corporate bond indexes. The authors find that these models provide information on the nature of credit events—that is, whether the event is systemic or not—and on the type of risk priced in corporate bonds (i.e., credit or liquidity risk). However, although the two models provide potentially useful information for policy-makers, at this stage it is difficult to corroborate the accuracy of the information obtained from them. Further work is needed before authorities can include conclusions drawn from the two models into their policy decisions.

Suggested Citation

  • Alejandro García & Andrei Prokopiw, 2009. "Measures of Aggregate Credit Conditions and Their Potential Use by Central Banks," Discussion Papers 09-12, Bank of Canada.
  • Handle: RePEc:bca:bocadp:09-12
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    File URL: http://www.bankofcanada.ca/en/res/dp/2009/dp09-12.pdf
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    Keywords

    Credit and credit aggregates; Financial markets; Financial stability;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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