Credit contagion in the presence of non-normal shocks

Enrique Bátiz-Zuk, George Christodoulakis and Ser-Huang Poon

International Review of Financial Analysis, 2015, vol. 37, issue C, 129-139

Abstract: We generalize existing structural credit risk models that account for contagion effects across economic sectors, to capture the impact of neglected skewness and excess kurtosis in the asset return process, on the shape of the credit loss distribution. We specify Skew-Normal and Skew-Student t densities for the underlying asset return process and estimate the derived credit loss density using sector default rates based on proprietary data from the Central Bank of Mexico for six firm sectors. We show that, out of the six sectors analyzed, there is a significant contagion effect in ‘Commerce’, ‘Services’ and ‘Transport’. Moreover, we show that the non-Gaussian modelling of the common factor provides a better characterization than its Gaussian counterpart for the ‘Services’ sector. This result has a significant impact on the shape and the corresponding Value-at-Risk levels of the ‘Services’ credit loss distribution. In this context, traditional Basel and vendor-based credit risk models are inadequate as these do not consider the individual or the joint impact of contagion and non-Gaussian asset returns.

Keywords: Vasicek–Merton credit loss distribution; Single factor model; Contagion; Basel; Non-Gaussian distributions; Skew-Normal; Skew-Student t (search for similar items in EconPapers)
JEL-codes: C13 C16 C22 G21 G32 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:37:y:2015:i:c:p:129-139

DOI: 10.1016/j.irfa.2014.11.014

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