Modeling Multi-Period Corporate Default Probability When Hazard Ratios Decay

Journal of Credit Risk, Forthcoming

15 Pages Posted: 27 Aug 2007 Last revised: 27 Apr 2012

See all articles by Jinggang Huang

Jinggang Huang

Standard & Poor's - Quantitative Analytics

Craig A. Friedman

State++

Date Written: August 14, 2007

Abstract

A number of researchers have used the Cox Proportional Hazard Model to estimate multi-period corporate default probabilities. By construction, models estimated in this manner have hazard ratios that are constant over time. We present evidence, drawn from historical data, indicating that empirical hazard ratios, in fact, exhibit pronounced decay over time, contrary to the assumptions of the Cox Proportional Hazard Model. We provide a possible explanation for this phenomenon, in terms of the evolution, posited by other authors, of the explanatory variables. We propose a hazard rate model with time varying coefficients, which incorporates the decaying hazard ratio property. Our model outperforms the standard Cox regression on an out-of-sample/time experiment.

Suggested Citation

Huang, Jinggang and Friedman, Craig A., Modeling Multi-Period Corporate Default Probability When Hazard Ratios Decay (August 14, 2007). Journal of Credit Risk, Forthcoming , Available at SSRN: https://ssrn.com/abstract=1008254 or http://dx.doi.org/10.2139/ssrn.1008254

Jinggang Huang (Contact Author)

Standard & Poor's - Quantitative Analytics ( email )

55 Water Street
New York, NY 10041
United States

Craig A. Friedman

State++ ( email )

New York, NY
United States

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