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From Fault Tree to Credit Risk Assessment: A Case Study

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  • Hayette Gatfaoui

Abstract

Reliability has been largely applied to industrial systems in order to study the various possibilities of systems’ failure. The goal is to establish the chain of events leading to any system’s failure, namely the top event. Looking for the minimal paths leading to any system’s fault allows for a better control of systems’ safety. To this end, reliability is composed of a static approach as well as a dynamic approach. In this paper, we extend the canonical framework allowing for the application of fault tree theory to credit risk assessment. The author explains that fault tree is one alternative approach of reliability, which matches default risk analysis in a simple framework. Our extension includes other distributions of probability to model the lifetimes of French firms while studying the related empirical default probabilities. We use mainly, but not exclusively, continuous distributions. Our results exhibit both the exponential nature of French .rms. lifetimes as well as strong convex and fast decreasing time varying failure rates. Such a feature has some non-negligible impact insofar as it characterizes corresponding credit spreads’ Term structure.

Suggested Citation

  • Hayette Gatfaoui, 2004. "From Fault Tree to Credit Risk Assessment: A Case Study," EERI Research Paper Series EERI_RP_2004_05, Economics and Econometrics Research Institute (EERI), Brussels.
    • Handle: RePEc:eei:rpaper:eeri_rp_2004_05
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    References listed on IDEAS

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    1. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    2. Lawrence Fisher, 1959. "Determinants of Risk Premiums on Corporate Bonds," Journal of Political Economy, University of Chicago Press, vol. 67, pages 217-217.
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    4. Ruud, Paul A., 2000. "An Introduction to Classical Econometric Theory," OUP Catalogue, Oxford University Press, number 9780195111644.
    5. M.J.B. Hall, 1996. "The amendment to the capital accord to incorporate market risk," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 49(197), pages 271-277.
    6. Robert A. Jarrow & Fan Yu, 2008. "Counterparty Risk and the Pricing of Defaultable Securities," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 20, pages 481-515, World Scientific Publishing Co. Pte. Ltd..
    7. Hayette Gatfaoui, 2003. "From Fault Tree to Credit Risk Assessment: An Empirical Attempt," Risk and Insurance 0308003, University Library of Munich, Germany.
    8. Linda Allen & Anthony Saunders, 2003. "A survey of cyclical effects in credit risk measurement model," BIS Working Papers 126, Bank for International Settlements.
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    More about this item

    Keywords

    Credit risk; default probability; failure rate; fault tree; reliability; survival;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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