Frailty Correlated Default

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Frailty Correlated Default

by Darrell Duffie of Stanford University,
Andreas Eckner of Stanford University,
Guillaume Horel of Stanford University, and
Leandro Saita of Lehman Brothers

October 19, 2006

Abstract: We analyze portfolio credit risk in light of dynamic "frailty," by which the credit qualities of different firms depend on common unobservable time-varying default covariates. Frailty is estimated to have a large impact on estimated conditional mean default rates, above and beyond those predicted by observable factors, and to cause a large increase in the likelihood of large default losses for portfolios of U.S. corporate bonds during 1980-2004.

JEL Classification: C11, C15, C41, E44, G33.

Keywords: correlated default, doubly stochastic, frailty, latent factor.

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