Abstract
The financial crises which occurred in the last several decades have demonstrated the significant impact of market structural breaks on firms’ credit behavior. To incorporate the impact of market structural break into the analysis of firms’ credit rating transitions and firms’ asset structure, we develop a continuous-time modulated Markov model for firms’ credit rating transitions with unobserved market structural breaks. The model takes a semi-parametric multiplicative regression form, in which the effects of firms’ observable covariates and macroeconomic variables are represented parametrically and nonparametrically, respectively, and the frailty effects of unobserved firm-specific and market-wide variables are incorporated via the integration form of the model assumption. We further develop a mixtured-estimating-equation approach to make inference on the effect of market variations, baseline intensities of all firms’ credit rating transitions, and rating transition intensities for each individual firm. We then use the developed model and inference procedure to analyze the monthly credit rating of U.S. firms from January 1986 to December 2012, and study the effect of market structural breaks on firms’ credit rating transitions.
Highlights
Several structural breaks in financial market have occurred during the last several decades so that market structural breaks seem to be common instead of exceptional
It has been noticed that firms may face different levels of credit risk during the periods of market structural breaks, even when firms’ capital structures do not change significantly; it is interesting to study the impact of market structural breaks on the relationship of firms’
Notice that traditional credit risk models assume the existence of this information set implicitly, and they usually specify a functional form with constant coefficient as the only element in St, that is, St = {Λθ }, where θ is a parameter vector and Λ is a functional for rating transition intensities
Summary
Several structural breaks in financial market have occurred during the last several decades so that market structural breaks seem to be common instead of exceptional. Various macroeconomic variables or market indices are proposed to characterize the movement of some market fundamentals, none of them are concerned with the effect of market structural changes on firms’ credit risk From this perspective, instability in financial market is a source of the movement or co-movement of firms’ credit risk, it cannot be represented as observed or unobserved risk factors, as in commonly-used credit risk models.
Sign-in/Register to view highlights & summary Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
