Beyond Macroeconomic Risk: The Role of Contagion in the Italian Corporate Default Correlation
37 Pages Posted: 8 May 2010
Date Written: June 30, 2009
The paper investigates the extent to which Italian corporate default correlation is due to the common dependence on macroeconomic (systematic) risk factors or, else, to other possibly unobservable factors arising from business inter-connections. Data on corporate default frequencies are taken from the Central Credit Register’s archive at industry level over the period March 1991 - March 2008. A system of equations is estimated to relate eight classes of industry-specific default rates to macroeconomic risk factors. We find that seven latent systematic factors summarizing macroeconomic conditions have a large impact on corporate default risk, but the residual correlation between the error terms of the estimated model’s equations suggests sectoral interdependence that might give rise to micro-contagion across sectors. Once contagion is identified, the model for corporate default rates is re-estimated using the leading macroeconomic variables and the latent contagion factors as explanatory variables in order to derive economic implications for macro-prudential analysis.
Keywords: Credit risk, common latent factors, systemic risk, contagion
JEL Classification: C32, E44, G21
Suggested Citation: Suggested Citation