Unobserved systematic risk factor and default prediction

Min Qi, Xiaofei Zhang and Xinlei Zhao

Journal of Banking & Finance, 2014, vol. 49, issue C, 216-227

Abstract: We conduct a thorough analysis on the role played by the unobserved systematic risk factor in default prediction. We find that this latent factor outweighs the observed systematic risk factors and can substantially improve the in-sample predictive accuracy at the firm, rating group, and aggregate levels. Thus it might be helpful to include the unobserved systematic risk factor when simulating portfolio credit losses. However, we also find that this factor only marginally improves out-of-sample model performance. Therefore, although the models we investigated all show reasonably good ability to rank order firms by default risk, accurate prediction of default rate remains challenging even when the unobserved systematic risk factor is considered.

Keywords: Observed systematic risk factors; Unobserved systematic risk factor; Corporate default prediction; Rank order; Predictive accuracy (search for similar items in EconPapers)
JEL-codes: G28 G33 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:49:y:2014:i:c:p:216-227

DOI: 10.1016/j.jbankfin.2014.09.009

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