The domino effect of credit defaults: test of asymmetric default correlations using realised default data

Leon Li and Carl Chen

Applied Economics, 2018, vol. 50, issue 44, 4803-4813

Abstract: Using the research framework of a domino effect in firms, we first make theoretical contributions by addressing several testable hypotheses regarding asymmetrical default correlations. We then employ Lucas’s method to provide empirical evidence based on realised historical default data in the United States from 1992 to 2013. Our empirical results are consistent with the following notions. First, default correlations increase with the time horizon. Second, firms with low credit quality, small size, illiquidity, and a high beta exhibit higher default correlations. Credit risk management without considering asymmetrical default correlations could underestimate portfolio risk due to default clustering.

Date: 2018
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DOI: 10.1080/00036846.2018.1467553

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