Splitting credit risk into systemic, sectorial and idiosyncratic components

Álvaro Chamizo and Alfonso Novales
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Álvaro Chamizo: BBVA.

No 2019-30, Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

Abstract: We provide a methodology to estimate a global credit risk factor from CDS spreads that can be very useful for risk management. The global risk factor (GRF) reproduces quite well the different epis- odes that have affected the credit market over the sample period. It is highly correlated with standard credit indices, but it contains much higher explanatory power for fluctuations in CDS spreads across sectors than the credit indices themselves. The additional information content over iTraxx seems to be related to some financial interest r ates. We first use the estimated GRF to analyze the extent to which the eleven sectors we consider are systemic. After that, we use it to split the credit risk of indi- vidual issuers into systemic, sectorial, and idiosyncratic components, and we perform some analyses to test that the estimated idiosyncratic components are actually firm-specific. The systemic and sec- torial components explain around 65% of credit risk in the European industrial and financial firms and 50% in the North American firms in those sectors, while 35% and 50% of risk, respectively, has an idiosyncratic nature. Thus, there is a significant margin for portfolio diversification. We also show that our decomposition allows us to identify those firms whose credit would be harder to hedge. We end up analyzing the relationship between the estimated components of risk and some synthetic risk factors, in order to learn about the different nature of the credit risk components.

Keywords: Credit Risk; Systemic Risk; Sectorial Risk; Idiosyncratic Risk; Asset Allocation. (search for similar items in EconPapers)
JEL-codes: C58 F34 G01 G32 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2019-09
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: Splitting Credit Risk into Systemic, Sectorial and Idiosyncratic Components (2019)
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