Self-exciting Corporate Defaults: Contagion vs. Frailty

Why do corporate defaults cluster? This paper explores the role of contagion, by which the default of a firm has a direct impact on the conditional default rates of the surviving firms, channeled through the complex web of contractual relationships in the economy. We develop filtered maximum likelihood estimators and goodness-of-fit tests for point processes to measure the additional impact of contagion on default rates, over and beyond that due to firms' exposure to observable or unobservable (frailty) risk factors. For U.S. firms during 1970--2006, we find strong evidence that contagion represents a significant additional source of default clustering.

Kay Giesecke, Stanford University

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