Credit Risk Modeling With Jointly Spanned and Unspanned Interest Rate and Unspanned Bei Rate: A Macro-Finance Approach

Abstract

The paper quantifies the influence of interest rates and inflation rates on default rates of banks. By expanding the work of Duffee (1998), with the unspanned risks as in Joslin et al (2014), we estimate a multifactor model with unspanned interest rates and inflation rates to test the performance of unspanned variables in the default rate term structure of banks. The model is trained in samples of positive interest rates and evaluated in samples of negative interest rates. We check the robustness of the model by comparing the results with the performance of alternative model specifications. The model reveals that unspanned variables have a worse performance than alternative models specifications.