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Does Credit Risk Vary with Economic Cycles? The Case of Finland

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Abstract

The significance of credit risk models has increased with the introduction of new Basel accord known as Basel II. The aim of this study is default rate modeling. This paper follows the two possible approaches of a macro credit risk modeling. First, empirical models are investigated. Second, a latent factor model based on Merton's idea is introduced. Both of these models are derived from individual default probability models. We employed data over the time period from 1988 to 2003 of the Finnish economy. First, linear vector autoregressive models were used in the case of dynamic empirical model. We examined how significant macroeconomic indicators determined the default rate in the economy. However these models cannot provide microeconomic foundation as latent factor models. A one-factor model was estimated using disaggregated industrial data. This estimation can help understand relation between credit risk and macroeconomic indicators. Models can be used for default rate prediction or stress testing by central authorities.

Suggested Citation

  • Petr Jakubík, 2006. "Does Credit Risk Vary with Economic Cycles? The Case of Finland," Working Papers IES 2006/11, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Apr 2006.
  • Handle: RePEc:fau:wpaper:wp2006_11
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    1. Lucas, Andre & Klaassen, Pieter, 2006. "Discrete versus continuous state switching models for portfolio credit risk," Journal of Banking & Finance, Elsevier, vol. 30(1), pages 23-35, January.
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    5. Pesola, Jarmo, 2001. "The role of macroeconomic shocks in banking crises," Research Discussion Papers 6/2001, Bank of Finland.
    6. 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.
    7. repec:wsi:ijtafx:v:08:y:2005:i:06:n:s0219024905003256 is not listed on IDEAS
    8. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, pages 199-232.
    9. 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.
    10. M. Tudela & G. Young, 2005. "A Merton-Model Approach To Assessing The Default Risk Of Uk Public Companies," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(06), pages 737-761.
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    Cited by:

    1. Petr JAKUBÍK, 2007. "Macroeconomic Environment and Credit Risk (in English)," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 57(1-2), pages 60-78, March.
    2. Dietske Simons & Ferdinand Rolwes, 2009. "Macroeconomic efault Modeling and Stress Testing," International Journal of Central Banking, International Journal of Central Banking, vol. 5(3), pages 177-204, September.
    3. Claudia Miani & Giulio Nicoletti & Alessandro Notarpietro & Massimiliano Pisani, 2012. "Banks� balance sheets and the macroeconomy in the Bank of Italy Quarterly Model," Questioni di Economia e Finanza (Occasional Papers) 135, Bank of Italy, Economic Research and International Relations Area.
    4. Takashi Hashimoto, 2009. "Asset correlation for credit risk analysis -- Empirical study of default data for Japanese companies --," Bank of Japan Working Paper Series 09-E-3, Bank of Japan.
    5. Guler Aras & Lale Aslan, 2011. "Capital structure and credit risk management: evidence from Turkey," International Journal of Accounting and Finance, Inderscience Enterprises Ltd, vol. 3(1), pages 1-20.
    6. International Monetary Fund, 2009. "Cyprus; Financial Sector Assessment Program Update: Technical Note: Measuring Banking Stability in Cyprus," IMF Staff Country Reports 09/171, International Monetary Fund.
    7. Düllmann, Klaus & Koziol, Philipp, 2013. "Evaluation of minimum capital requirements for bank loans to SMEs," Discussion Papers 22/2013, Deutsche Bundesbank.
    8. Salnikov, V. & Mogilat, A. & Maslov, I., 2012. "Stress Testing for Russian Real Sector: First Approach," Journal of the New Economic Association, New Economic Association, vol. 16(4), pages 46-70.

    More about this item

    Keywords

    banking; credit risk; latent factor model; default rate;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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