Default, Liquidity and Crises: An Econometric Framework
National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST); National Bureau of Economic Research (NBER); Maastricht University
Banque de France
August 1, 2011
Banque de France Working Paper No. 340
In this paper, we present a general discrete-time affine framework aimed at jointly modeling yield curves associated with different debtors. The underlying fixed-income securities may differ in terms of credit quality and/or in terms of liquidity. The risk factors follow conditionally Gaussian processes, with drifts and variance-covariance matrices that are subject to regime shifts described by a Markov chain with (historical) non-homogenous transition probabilities. While flexible, the model remains tractable. In particular, bond prices are given by quasi-explicit formulas. Various numerical examples are proposed, including a sector-contagion model and credit-rating modeling.
Number of Pages in PDF File: 44
Keywords: credit risk, liquidity risk, term structure, affine model, regime switching, car process
JEL Classification: E43, E44, E47, G12, G24
Date posted: August 19, 2011 ; Last revised: December 11, 2011
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