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A Causal Framework for Credit Default Theory

  • Wilson Sy

    (Australian Prudential Regulatory Authority)

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    Most existing credit default theories do not link causes directly to the effect of default and are unable to evaluate credit risk in a rapidly changing market environment, as experienced in the recent mortgage and credit market crisis. Causal theories of credit default are needed to understand lending risk systematically and ultimately to measure and manage credit risk dynamically for financial system stability. Unlike existing theories, credit default is treated in this paper by a joint model with dual causal processes of delinquency and insolvency. A framework for developing causal credit default theories is introduced through the example of a new residential mortgage default theory. This theory overcomes many limitations of existing theories, solves several outstanding puzzles and integrates both micro and macroeconomic factors in a unified financial economic theory for mortgage default.

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    Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 204.

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    Length: 28 pages
    Date of creation: 01 Oct 2007
    Date of revision:
    Handle: RePEc:uts:rpaper:204
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