A Non-Gaussian Panel Time Series Model for Estimating and Decomposing Default Risk

Siem Jan Koopman and Andre Lucas

Journal of Business & Economic Statistics, 2008, vol. 26, 510-525

Abstract: We model 1981–2005 quarterly default frequencies for a panel of U.S. firms in different rating and age classes from the Standard and Poor database. The data are decomposed into systematic and firm-specific risk components, where the systematic component reflects the general economic conditions and the default climate. We need to cope with: the shared exposure of each age cohort, industry, and rating class to the same systematic risk factor; strongly non-Gaussian features of the individual time series; possible dynamics of an unobserved common risk factor; changing default probabilities over the age of the rating; and missing observations. We propose a non-Gaussian multivariate state-space model that deals with all of these issues simultaneously. The model is estimated using importance sampling techniques that have been modified to a multivariate setting. We show in a simulation study that such a multivariate approach improves the performance of the importance sampler. In our empirical work, we find that systematic credit risk may differ substantially in terms of magnitude and timing across industries.

Date: 2008
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Working Paper: A Non-Gaussian Panel Time Series Model for Estimating and Decomposing Default Risk (2005)
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