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Frailty Correlated Default
Author(s) -
DUFFIE DARRELL,
ECKNER ANDREAS,
HOREL GUILLAUME,
SAITA LEANDRO
Publication year - 2009
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2009.01495.x
Subject(s) - collateralized debt obligation , loss given default , debt , econometrics , probability of default , portfolio , economics , default , actuarial science , capital requirement , business , financial economics , credit risk , collateral , finance , microeconomics , incentive
The probability of extreme default losses on portfolios of U.S. corporate debt is much greater than would be estimated under the standard assumption that default correlation arises only from exposure to observable risk factors. At the high confidence levels at which bank loan portfolio and collateralized debt obligation (CDO) default losses are typically measured for economic capital and rating purposes, conventionally based loss estimates are downward biased by a full order of magnitude on test portfolios. Our estimates are based on U.S. public nonfinancial firms between 1979 and 2004. We find strong evidence for the presence of common latent factors, even when controlling for observable factors that provide the most accurate available model of firm‐by‐firm default probabilities.