Disastrous Defaults

Christian Gouriéroux, Alain Monfort, Sarah Mouabbi and Jean-Paul Renne

No 21-1237, TSE Working Papers from Toulouse School of Economics (TSE)

Abstract: We define a disastrous default as the default of a systemic entity, which has a negative effect on the economy and is contagious. Bringing macroeconomic structure to a no-arbitrage asset pricing framework, we exploit prices of disaster-exposed assets (credit and equity derivatives) to extract information on the expected (i) influence of a disastrous default on consumption and (ii) probability of a financial meltdown. Using European data, we find that the returns of disaster-exposed assets are consistent with a systemic default being followed by a 2% decrease in consumption. The recessionary influence of disastrous defaults implies that financial instruments whose payoffs are exposed to such credit events carry substantial risk premiums. We also produce systemic risk indicators based on the probability of observing a certain number of systemic defaults or a sharp drop of consumption.

JEL-codes: E43 E44 E47 G01 G12 (search for similar items in EconPapers)
Date: 2021-08-02
New Economics Papers: this item is included in nep-ban, nep-fdg, nep-mac and nep-rmg
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Citations: View citations in EconPapers (1)

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Journal Article: Disastrous Defaults* (2021)
Working Paper: Disastrous Defaults (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:tse:wpaper:125843

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