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Credit risk

About: Credit risk is a research topic. Over the lifetime, 18595 publications have been published within this topic receiving 382866 citations.


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Journal ArticleDOI
TL;DR: In this article, the authors provide robust evidence of deviations from the Covered Interest Parity (CIP) relation since the onset of the crisis in August 2007 and show that the CIP deviations exist with respect to different dollar interest rates and exchange rate pairs of the dollar vis-a-vis other currencies.
Abstract: We provide robust evidence of deviations from the Covered Interest Parity (CIP) relation since the onset of the crisis in August 2007. The CIP deviations exist with respect to different dollar interest rates and exchange rate pairs of the dollar vis-a-vis other currencies. The results show that our proxies for margin conditions and cost of capital are significant determinants of the basis. Following the bankruptcy of Lehman Brothers, uncertainty about counterparty risk became a significant determinant of CIP deviations. The supply of dollars by the Federal Reserve to foreign central banks via reciprocal currency arrangements (swap lines) reduced CIP deviations. In particular, the announcement on October 13 2008 that the swap lines would become unlimited reduced CIP deviations substantially. These results indicate a breakdown of arbitrage transactions in the international capital markets during the crisis partly due to lack of funding and partly due to heightened counterparty credit risk. Central bank interventions helped to reduce the funding liquidity risk of global institutions.

141 citations

01 Jan 2001
TL;DR: In this article, the authors show that the drift adjustment on the state variables underlying the martingale default intensity is not an equivalence in distribution, and illustrate its importance using credit spread dynamics estimated in Duffee (1999).
Abstract: Recent advances in the theory of credit risk allow the use of standard term structure machinery for default risk modeling and estimation. The empirical literature in this area often interprets the drift adjustments of the default intensity’s diffusion state variables as the only default risk premium. We show that this interpretation implies a restriction on the form of possible default risk premia, which can be justified through exact and approximate notions of “diversifiable default risk.” The equivalence between the empirical and martingale default intensities that follows from diversifiable default risk greatly facilitates the pricing and management of credit risk. We emphasize that this is not an equivalence in distribution, and illustrate its importance using credit spread dynamics estimated in Duffee (1999). We also argue that the assumption of diversifiability is implicitly used in certain existing models of mortgage-backed securities. Reduced-form models of defaultable securities, which view the default of corporate bond issuers as an unpredictable event, have become a popular tool in credit risk modeling. A key advantage of this approach is that it brings into play the machinery of classical term structure modeling techniques. This is convenient for the econometric specification of models for credit risky bonds as well as for the pricing of credit derivatives. The strong analogy with ordinary term structure modeling, which will be briefly recalled in the next section, allows for specifications of default intensities and short rates using for example the affine term structure machinery of which the models by Cox, Ingersoll and Ross (1985) and Vasicek (1977) are the classic examples.1 Pricing bonds and derivatives in this framework requires only the evolution of the state variables under an equivalent martingale measure. However, in order to understand the factor risk premia in bond markets and to utilize time-series information in the empirical estimation, a joint specification of the evolution of the state variables under the “physical measure” and the equivalent martingale measure is required. The structure of these risk premia is well understood, for example, in the affine models of the term structure. A key concern in our understanding of the corporate bond market is the form and size of the risk premia for default risk. Since the reduced-form approach allows us to model default risk using standard term structure machinery, it is natural to use the same structure for the risk premia of the intensity processes as we would use for the short rate process in ordinary term structure models. This choice has led to an interpretation of the drift adjustment on the state variables underlying the martingale default intensity as a “default risk premium” or “price of default risk.”2 Recent examples of this approach are the empirical works by Duffie and Singleton (1997), Duffee (1999), and Liu, Longstaff and Mandell (2001). The last paper proceeds a step further along the risk premium interpretation by computing the expected returns on defaultable bonds using these drift adjustments. We show in this paper that this specification for the default risk premia implies a strong re- striction on the set of possible risk premia. The fact that the intensity process is not just an affine function of diffusion state variables but is also the compensator of a jump process allows for a much richer class of risk premia. The critical distinction is really whether agents only price variations in the default intensity, which then must be pervasive, or they also price the default event itself. This insight can be derived from existing works such as Back (1991) and Jarrow and Madan (1995). Through the well-known connection between the state-price density and the marginal utility of a representative investor or a single optimizing agent, it is easy to see that the structure of the default risk premia used in the current empirical literature implies that there can be no For more general works on affine models, see for example Duffie and Kan (1996) and Dai and Singleton (2000). To be precise, the martingale intensity is usually assumed to depend on short rate factors. This is to capture the systematic dependence of credit spreads on the default-free term structure. The drift adjustments on these short rate factors are appropriately interpreted as interest rate risk premia. However, usually one more state variable is included for the intensity and its risk adjustment is given the interpretation of a default risk premium.

141 citations

Journal ArticleDOI
TL;DR: This paper conducted an analysis of the possible determinants of sovereign credit ratings assigned by the two leading credit rating agencies, Moody's and Standard and Poor's, by using both a linear and a logistic transformation of the rating scales.
Abstract: I conduct an analysis of the possible determinants of sovereign credit ratings assigned by the two leading credit rating agencies, Moody's and Standard and Poor's, by using both a linear and a logistic transformation of the rating scales. Of the large number of variables that can be used, the set of explanatory variables selected in this study is significant in explaining the credit ratings. Namely, six variables appear to be the most relevant to determine a country's credit rating: GDP per capita, external debt, level of economic development, default history, real growth rate and inflation rate.

141 citations

Posted Content
TL;DR: In this paper, an event study of rating change announcements by leading international rating agencies, focussing on a sample of European banks, was conducted to investigate the effect of rating changes on stock prices.
Abstract: The recent consultative papers by the Basel Committee suggest an explicit role for external rating agencies in the assessment of the credit risk of banks' assets. In this context, an assessment of the information contained in credit ratings is important. We address this issue via an event study of rating change announcements by leading international rating agencies, focussing on a sample of European banks. We find no evidence of announcement effects on bond prices. We are largely able to exclude lack of liquidity as an explanation for this puzzling result and suggest some alternatives, such as "too-big-to-fail." For equity prices, we find strong effects of unexpected ratings changes and confirm prior evidence that stock prices may react very differently to ratings downgrades, depending on the underlying reason. Overall, our results suggest that ratings agencies may perform a useful role in summarising and obtaining non-public information on banks, at least for stockholders.

141 citations

Journal ArticleDOI
TL;DR: In this article, the authors examined how the information quality of ratings from an issuer-paid rating agency (Standard and Poor's) responds to the entry of an investor paid rating agency, the Egan-Jones Rating Company (EJR), by comparing S&P's ratings quality before and after EJR initiates coverage of each firm.

141 citations


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Performance
Metrics
No. of papers in the topic in previous years
YearPapers
20251
2023343
2022729
2021799
2020915
2019921