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| Corporate Credit Risk Modelling and the Macroeconomy by Kenneth Carling of IFAU and Dalarna University, December 3, 2004 Abstract: Despite a surge in the research efforts put into modelling credit risk during the past decade, few studies have incorporated the impact that macroeconomic conditions have on business defaults. In this paper, we estimate a duration model to explain the survival time to default for counterparts in the business loan portfolio of a major Swedish bank over the period 1994-2000. The model takes both firm specific characteristics, such as accounting ratios and payment behaviour, loan related information, and the macroeconomic stance into account. The output gap, the yield curve and consumers' expectations of future economic development have significant explanatory power for the default risk of firms. We also derive two measures of portfolio credit risk, Value-at-Risk-type and Expected Shortfall, by means of a Monte-Carlo simulation method that employs model-based probabilities of default. This two-step approach allows us to (i) make individual forecasts of default risk conditional on firm and loan characteristics, as well as prevailing macroeconomic conditions, (ii) study the evolution of portfolio credit risk over time while conditioning on the macroeconomy. We also compare our model with a frequently used model of firm default risk that conditions only on firm-specific information. The comparison shows that while the latter model can make a reasonably accurate ranking of firms' according to default risk, our model, by taking macro conditions into account, is also able to pin down the absolute level of (default, and thus also credit) risk. JEL Classification: C41, G21, G33, G38. Keywords: default risk modeling, credit risk, corporate loans, Value-at-Risk, expected shortfall, duration, macroeconomic conditions. Published in: Journal of Banking & Finance, Vol. 31, No. 3, (March 2007), pp. 845-868. Books Referenced in this Paper: (what is this?)
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