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Default prediction with dynamic sectoral and macroeconomic frailties |
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| Institution: | 1. School of Economic Mathematics, Southwestern University of Finance and Economics, Chengdu, Sichuan 611130, China;2. School of Management, State University of New York at Buffalo, Buffalo, NY 14260, USA;1. School of Business, University of Alberta, Canada;2. Department of Economics, Hitotsubashi University, Japan;1. Faculty of Economics and Business, University of Groningen, The Netherlands;2. Division of Economics, University of Stirling, United Kingdom;1. Finance Discipline Group, UTS Business School, University of Technology, Sydney;2. San Jose State University, San Jose, CA, United States |
| Abstract: | This paper extends the macroeconomic frailty model to include sectoral frailty factors that capture default correlations among firms in a similar business. We estimate sectoral and macroeconomic frailty factors and their effects on default intensity using the data for Japanese firms from 1992 to 2010. We find strong evidence for the presence of sectoral frailty factors even after accounting for the effects of observable covariates and macroeconomic frailty on default intensity. The model with sectoral frailties performs better than that without. Results show that accounting for the sources of unobserved sectoral default risk covariations improves the accuracy of default probability estimation. |
| Keywords: | Default risk Hazard rate function Frailty Distance to default Tail loss Monte Carlo expectations maximization (EM) Gibbs sampler |
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