Working paper: Modeling frailty correlated defaults with multivariate latent factors

Working paper - January 2020 - No. 151

Authors Christoffersen, Benjamin (Copenhagen Business School); Matin, Rastin (Danmarks Nationalbank)
Subject Credit risk; Risk management
Type Working paper
Year 2020
Published 22 January 2020
It is typically assumed within corporate default modeling that the covariates have a linear effect on the log-hazard scale, no interactions, and that there is only a single additive latent factor on the log-hazard scale. Using a sample of US corporate firms, we show in this paper that these standard assumptions are too strict and that they matter in practice. We propose instead a frailty-model that relaxes these assumptions and takes into account time-varying covariates, while being able to provide forecasts for arbitrary portfolios.