Multiperiod Corporate Default Prediction with the Partially-Conditioned Forward Intensity
37 Pages Posted: 24 Sep 2012 Last revised: 18 Oct 2013
Date Written: August 21, 2013
Abstract
The forward-intensity model of Duan, {et al} (2012) is a parsimonious and practical way for predicting corporate defaults over multiple horizons. However, it has a noticeable shortcoming because default correlations through intensities are conspicuously absent when the prediction horizon is more than one data period. We propose a new forward-intensity approach that builds in correlations among intensities of individual obligors by conditioning all forward intensities on the future values of some common variables, such as the observed interest rate and/or a latent frailty factor. The new model is implemented on a large sample of US industrial and financial firms spanning the period 1991-2011 on the monthly frequency. Our findings suggest that the new model is able to correct the structural biases at longer prediction horizons reported in Duan et al (2012). Not surprisingly, default correlations are also found to be important in describing the joint default behavior.
Keywords: default, forward default intensity, pseudo-bayesian inference, sequential monte carlo, self-normalized asymptotics
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