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Measuring Corporate Default Risk$
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Darrell Duffie

Print publication date: 2011

Print ISBN-13: 9780199279234

Published to Oxford Scholarship Online: September 2011

DOI: 10.1093/acprof:oso/9780199279234.001.0001

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Empirical Evidence of Frailty

Empirical Evidence of Frailty

(p.59) 7 Empirical Evidence of Frailty
Measuring Corporate Default Risk

Darrell Duffie

Oxford University Press

This chapter provides strong evidence of missing common or correlated default risk factors, some of which may not even have been contemporaneously available. Based on this idea, it provides estimates of a frailty-based model of joint default arrivals, in which default correlation can arise from variables that might have been available to the econometrician but were not included in the model, and also from additional unobservable sources of correlation. The results show substantial dependence of default intensities on common unobservable (or at least un-included) factors whose effects are condensed for modeling purposes into a single multiplicative dynamic factor, parameterized as an Ornstein–Uhlenbeck frailty process. The estimated parameters governing the mean reversion and volatility of this frailty process, as well as the posterior (filtered) probability distribution of the frailty process, indicate substantial persistence and time variation in hidden common default risk.

Keywords:   corporation, default, risk, empirical estimation, default intensity, Ornstein–Uhlenbeck frailty process, default correlation, frailty

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