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Bank default indicators with volatility clustering

Turalay Kenc (), Emrah Çevik () and Selahattin Dibooglu
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Turalay Kenc: TOBB University of Economics and Technology

Annals of Finance, 2021, vol. 17, issue 1, No 5, 127-151

Abstract: Abstract We estimate default measures for US banks using a model capable of handling volatility clustering like those observed during the Global Financial Crisis (GFC). In order to account for the time variation in volatility, we adapted a GARCH option pricing model which extends the seminal structural approach of default by Merton (J Finance 29(2):449, 1974) and calculated “distance to default” indicators that respond to heightened market developments. With its richer volatility dynamics, our results better reflect higher expected default probabilities precipitated by the GFC. The diagnostics show that the model generally outperforms standard models of default and offers relatively good indicators in assessing bank failures.

Keywords: Default risk; Structural credit risk models; Contingent claims; GARCH option pricing; Bank defaults; G01; G21; G28 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10436-020-00369-x

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