Business and Financial Indicators: What are the Determinants of Default Probability Changes?

45 Pages Posted: 5 Nov 2006

See all articles by Fabien Couderc

Fabien Couderc

École Polytechnique Fédérale de Lausanne; Axioma Inc

Olivier Renault

University of Warwick Business School - Financial Econometrics Research Centre

Date Written: December 10, 2005

Abstract

This paper investigates some common determinants of default probability changes of individual firms using Standard & Poor's ratings database. We analyze and quantify the responses of hazard rates to changes in various economic variables, namely financial markets, business cycle and credit indicators, and examine their persistency. First, we show that including non-financial information largely improves the poor explanatory power of financialbased factor models. More importantly, in comparison with market factors, business and credit factors become dominant as the issuer quality decreases. Second, we highlight the benefits of past information. Our results prove that both past shocks and subsequent economic trends are of prime importance in explaining probability changes. To draw these conclusions, we introduce a semi-parametric framework accommodating the continuous nature of probability changes and ageing effects. It allows us to recover default probabilities over any desired time horizon.

Keywords: censored durations, proportional hazard, business cycle, default

JEL Classification: C14, C41, G20, G33

Suggested Citation

Couderc, Fabien and Couderc, Fabien and Renault, Olivier M., Business and Financial Indicators: What are the Determinants of Default Probability Changes? (December 10, 2005). Available at SSRN: https://ssrn.com/abstract=942236 or http://dx.doi.org/10.2139/ssrn.942236

Fabien Couderc (Contact Author)

École Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Axioma Inc ( email )

17 State Street, Suite 800
New York, NY 10004
United States

Olivier M. Renault

University of Warwick Business School - Financial Econometrics Research Centre ( email )

Coventry CV4 7AL
United Kingdom

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