Modeling Frailty Correlated Defaults With Multivariate Latent Factors

24 Pages Posted: 14 Mar 2019 Last revised: 11 Jul 2019

See all articles by Benjamin Christoffersen

Benjamin Christoffersen

Copenhagen Business School - Department of Finance

Rastin Matin

National Bank of Denmark

Date Written: July 09, 2019

Abstract

Firm-level default models are important for bottom-up modeling of the default risk of corporate debt portfolios. However, models in the literature typically have several strict assumptions which may yield biased results, notably a linear effect of covariates on the log-hazard scale, no interactions, and the assumption of a single additive latent factor on the log-hazard scale. Using a sample of US corporate firms, we provide evidence that these assumptions are too strict and matter in practice and, most importantly, we provide evidence of a time-varying effect of the relative firm size. We propose a frailty model to account for such effects that can provide forecasts for arbitrary portfolios as well. Our proposed model displays superior out-of-sample ranking of firms by their default risk and forecasts of the industry-wide default rate during the recent global financial crisis.

Keywords: frailty models, corporate default models

JEL Classification: G33, G17

Suggested Citation

Christoffersen, Benjamin and Matin, Rastin, Modeling Frailty Correlated Defaults With Multivariate Latent Factors (July 09, 2019). Available at SSRN: https://ssrn.com/abstract=3339981 or http://dx.doi.org/10.2139/ssrn.3339981

Benjamin Christoffersen (Contact Author)

Copenhagen Business School - Department of Finance ( email )

A4.17 Solbjerg Plads 3
Copenhagen, Frederiksberg 2000
Denmark

Rastin Matin

National Bank of Denmark ( email )

Havnegade 5
DK-1093 Copenhagen K
Denmark

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
58
Abstract Views
521
rank
405,941
PlumX Metrics