Nonlinear Modeling of Financial Stability Using Default Probabilities from the Capital Market

Lucian Albu (), Radu Lupu (), Adrian Cantemir Calin and Iulia Lupu

Journal for Economic Forecasting, 2019, issue 1, 19-37

Abstract: Our study relies on a general assumption that prices contain a rational component, which is consistent with the rational expectations theory, and an irrational one, better explained by behavioural economics. We decompose the probabilities of default computed by Bloomberg for the listed Romanian companies by filtering the irrational component with newly proposed gauges. To check for the relevance of the rationality component, we use MiDaS models to study the relation with sectoral GDP gap dynamics for the corresponding companies. Employing regression related methods, we further divide the irrational part of default probabilities into a measure for fear and a measure for habit. After each transformation, we check the connection with the corresponding sectoral GDP gap. Our objective is to investigate the extent to which there is a connection between the macroeconomic expected activity, measured by the sectoral GDP gap and the risk of companies listed at the Bucharest Stock Exchange, quantified by probabilities of default. We embark on this journey with the assumption that the irrational component obfuscates the above-mentioned connections.

Keywords: probabilities of default; fear; loss aversion; asymmetric volatility; day-of-the-week-effect; MiDaS regressions (search for similar items in EconPapers)
JEL-codes: G12 G17 G41 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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