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From Fault Tree to Credit Risk Assessment: An Empirical Attempt

Listed author(s):
  • Hayette Gatfaoui

    (The University of Paris 1 - Panthéon-Sorbonne)

Since 80’, fault tree theory has known a great development in industrial systems’ sector. Its first goal is to estimate and model the probability and events combination which could lead a given system to failure. Later static and dynamic studies arise such as Dugan, Venkataraman & Gulati (1997), Gulati & Dugan (1997) and Ngom et al. (1999) for example. Improvements are also proposed by Anand & Somani (1998)[REF], Zhu et al. (2001)[REF] and Reory & Andrews (2003)[REF] among others. Since credit risk valuation attempts to quantify firms’ default risk, we propose to apply one alternative approach of fault tree, or equivalently, reliability study to assess firms’ default risk. We set a very simple framework and use French firms’ bankruptcy statistics to quantify default probabilities. From these empirical default probabilities and under the assumption that the lifetime process follows an exponential law with a constant parameter, we estimate this constant parameter for French sectors. Each parameter’s estimation corresponds to the related hazard rate over the time horizon under consideration. Checking for the consistency of our constant parameter’s assumption, we compute the monthly implied parameters related to our exponential law setting. Results show a time varying behavior for those parameters. Indeed, each exponential law’s parameter is a convex decreasing function of time. Whatever, such an approach may be useful to give a statistical benchmark for common credit risk models’ improvement.

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Paper provided by EconWPA in its series Risk and Insurance with number 0308003.

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Length: 27 pages
Date of creation: 25 Aug 2003
Handle: RePEc:wpa:wuwpri:0308003
Note: Type of Document - Acrobat PDF; prepared on PC; to print on HP/PostScript; pages: 27 ; figures: included. This paper is under submission for the Journal of Risk.
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  1. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453 World Scientific Publishing Co. Pte. Ltd..
  2. Robert A. Jarrow & Stuart M. Turnbull, 2008. "Pricing Derivatives on Financial Securities Subject to Credit Risk," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409 World Scientific Publishing Co. Pte. Ltd..
  3. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
  4. Barlow, Richard E. & Proschan, Frank, 1975. "Importance of system components and fault tree events," Stochastic Processes and their Applications, Elsevier, vol. 3(2), pages 153-173, April.
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