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Original Articles

Dynamic Factor Models With Macro, Frailty, and Industry Effects for U.S. Default Counts: The Credit Crisis of 2008

, &
Pages 521-532
Received 01 Jun 2011
Accepted author version posted online: 29 Jun 2012
Published online:17 Oct 2012
 

We develop a high-dimensional, nonlinear, and non-Gaussian dynamic factor model for the decomposition of systematic default risk conditions into latent components for (1) macroeconomic/financial risk, (2) autonomous default dynamics (frailty), and (3) industry-specific effects. We analyze discrete U.S. corporate default counts together with macroeconomic and financial variables in one unifying framework. We find that approximately 35% of default rate variation is due to systematic and industry factors. Approximately one-third of this systematic variation is captured by the macroeconomic and financial factors. The remainder is captured by frailty (40%) and industry (25%) effects. The default-specific effects are particularly relevant before and during times of financial turbulence. We detect a build-up of systematic risk over the period preceding the 2008 credit crisis. This article has online supplementary material.

ACKNOWLEDGMENTS

We thank the editor and the referees for their insightful comments. The article has improved considerably as a result. We also thank Arthur Korteweg (discussant at 2011 AFA meeting in Denver), Kasper Roszbach (discussant at Atlanta Fed’s day ahead conference), Alexandre Adam (discussant at 2009 CREDIT conference in Venice), and participants at 2009 SoFiE credit risk conference in Chicago. We finally thank seminar participants at European Central Bank, Swedish National Bank, Tinbergen Institute, and University of Amsterdam, as well as Robert Engle, Kay Giesecke, Philipp Hartmann, David Lando, and Michel van der Wel. André Lucas thanks the Dutch National Science Foundation (NWO) for financial support.

The views expressed in this article are those of the authors and they do not necessarily reflect the views or policies of the European Central Bank or the European System of Central Banks.