Business and Default Cycles for Credit Risk

Tinbergen Institute Discussion Paper No. 03-062/2

23 Pages Posted: 29 Sep 2003

See all articles by Siem Jan Koopman

Siem Jan Koopman

Vrije Universiteit Amsterdam - School of Business and Economics; Tinbergen Institute; Aarhus University - CREATES

Andre Lucas

Vrije Universiteit Amsterdam - School of Business and Economics; Tinbergen Institute

Date Written: December 24, 2003

Abstract

Various economic theories are available to explain the existence of credit and default cycles. There remains empirical ambiguity, however, as to whether or these cycles coincide. Recent papers suggest by their empirical research set-up that they do, or at least that defaults and credit spreads tend to co-move with macroeconomic variables. If true, this is important for credit risk management as well as for regulation and systemic risk management. In this paper, we use 1927-1997 U.S. data on real GDP, credit spreads, and business failure rates to shed new light on the empirical evidence. We use a multivariate unobserved components framework to disentangle credit from business cycles. It turns out that cyclical co-movements arise between default rates, but not real GDP. There is, however, a contemporaneous correlation between real GDP and default rates. Regarding the longer term evolution of the series, credit spreads influence default rates and real GDP, but not vice versa. This corroborates some of the empirical findings in the recent literature on the correlation between macrovariables and default rates. It also suggests the use of credit spreads besides or instead of economic growth rates to forecast the dynamics of future default rates.

Keywords: credit cycles, business cycles, defaults, credit risk, procyclicality, multivariate unobserved component models

JEL Classification: C19, G21

Suggested Citation

Koopman, Siem Jan and Lucas, Andre, Business and Default Cycles for Credit Risk (December 24, 2003). Tinbergen Institute Discussion Paper No. 03-062/2, Available at SSRN: https://ssrn.com/abstract=438160 or http://dx.doi.org/10.2139/ssrn.438160

Siem Jan Koopman (Contact Author)

Vrije Universiteit Amsterdam - School of Business and Economics ( email )

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HOME PAGE: http://sjkoopman.net

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Aarhus University - CREATES ( email )

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Andre Lucas

Vrije Universiteit Amsterdam - School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands
+31 20 598 6039 (Phone)
+31 20 598 6020 (Fax)

HOME PAGE: http://personal.vu.nl/a.lucas

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