Global Business Cycles and Credit Risk (original) (raw)
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The Role of Industry, Geography and Firm Heterogeneity in Credit Risk Diversification
Social Science Research Network, 2005
In theory the potential for credit risk diversi…cation for banks could be substantial. Portfolios are large enough that idiosyncratic risk is diversi…ed away leaving exposure to systematic risk. The potential for portfolio diversi…cation is driven broadly by two characteristics: the degree to which systematic risk factors are correlated with each other and the degree of dependence individual …rms have to the di¤erent types of risk factors. We propose a model for exploring these dimensions of credit risk diversi…cation: across industry sectors and across di¤erent countries or regions. We …nd that full …rm-level parameter heterogeneity matters a great deal for capturing di¤erences in simulated credit loss distributions. Imposing homogeneity results in overly skewed and fat-tailed loss distributions. These di¤erences become more pronounced in the presence of systematic risk factor shocks: increased parameter heterogeneity greatly reduces shock sensitivity. Allowing for regional parameter heterogeneity seems to better approximate the loss distributions generated by the fully heterogeneous model than allowing just for industry heterogeneity. The regional model also exhibits less shock sensitivity.
Business and Default Cycles for Credit Risk
SSRN Electronic Journal, 2000
Various economic theories are available to explain the existence of credit and default cycles. There remains empirical ambiguity, however, as to whether these cycles coincide. Recent papers suggest by their empirical research set-up that they do, or at least that defaults and credit spreads tend to co-move with macro-economic variables. If true, this is important for credit risk management as well as for regulation and systemic risk management. In this paper, we use 1933-1997 U.S. data on real GDP, credit spreads, and business failure rates to shed new light on the empirical evidence. We use a multivariate unobserved components framework to disentangle credit and business cycles. We distinguish two types of cycles in the data, corresponding to periods of around 6 and 11-16 years, respectively. Cyclical co-movements between GDP and business failures mainly arise at the longer frequency. At the higher frequency of 6 years, co-cyclicality is less clear-cut. We also show that spreads reveal a positive and negative co-cyclicality with failure rates and GDP, respectively. This pattern disappears, however, if we concentrate on the post World War II period. We comment on the implications of our findings for credit risk management.
Macroeconomics and Credit Risk: A Global Perspective
SSRN Electronic Journal, 2000
This paper presents a new approach to modeling conditional credit loss distributions. Asset value changes of firms in a credit portfolio are linked to a dynamic global macroeconometric model, allowing macro effects to be isolated from idiosyncratic shocks from the perspective of default (and hence loss). Default probabilities are driven primarily by how firms are tied to business cycles, both domestic and foreign, and how business cycles are linked across countries. We allow for firm-specific business cycle effects and the heterogeneity of firm default thresholds using credit ratings. The model can be used, for example, to compute the effects of a hypothetical negative equity price shock in South East Asia on the loss distribution of a credit portfolio with global exposures over one or more quarters. We show that the effects of such shocks on losses are asymmetric and non-proportional, reflecting the highly non-linear nature of the credit risk model.
2018
This paper stresses a new channel through which global financial linkages contribute to the co-movement in economic activity across countries. We show in a two-country setting with borrowing constraints that international credit markets are subject to self-fulfilling variations in the world real interest rate. Those expectation-driven changes in the borrowing cost in turn act as global shocks that induce strong cross-country co-movements in both financial and real variables (such as asset prices, GDP, consumption, investment and employment). When firms around the world benefit from unexpectedly low debt repayments, they borrow and invest more, which leads to excessive supply of collateral and of loanable funds at a low interest rate, thus fueling a boom in both home and abroad. As a consequence, business cycles are synchronized internationally. Such a stylized model thus offers one way to rationalize both the existence of a world business-cycle component, documented by recent empiri...
Macroeconomic Dynamics and Credit Risk: A Global Perspective
Journal of Money, Credit, and Banking, 2006
We develop a framework for modeling conditional loss distributions through the introduction of risk factor dynamics. Asset value changes of a credit portfolio are linked to a dynamic global macroeconometric model, allowing macro effects to be isolated from idiosyncratic shocks. Default probabilities are driven primarily by how firms are tied to business cycles, both domestic and foreign, and how business cycles are linked across countries. The model is able to control for firm-specific heterogeneity as well as generate multi-period forecasts of the entire loss distribution, conditional on specific macroeconomic scenarios.
Credit Risk and Business Cycle Over Different Regimes
SSRN Electronic Journal, 2008
In the recent banking literature, the relationships between credit risk and the business cycle have been analyzed for both (macro) financial stability and (micro) risk management purposes. The vast majority of these studies generally neglect the presence of asymmetric effects, i.e., the possibility that the impact is dissimilar over different phases of the business cycle. In this paper, we try to make a step forward and shed some light on these open issues. For our analysis, we employ Threshold Regression models with two or more regimes both at the aggregate and at the individual level, exploiting a unique dataset on Italian bank borrowers' default rates. In particular, we analyze whether the relationship between business cycle and credit risk is subject to regime switches, determining endogenously the thresholds. Furthermore, we test whether the impact of the business cycle is more pronounced when credit risk starts at higher levels, endogenously identifying the risk threshold over/below which such impact is different. Our results suggest that the impact of the business cycle is more pronounced when starting credit risk levels are higher and during downturns.
Global banking and international business cycles
European Economic Review, 2011
This paper incorporates a global bank into a two-country business cycle model. The bank collects deposits from households and makes loans to entrepreneurs, in both countries. It has to finance a fraction of loans using equity. We investigate how such a bank capital requirement affects the international transmission of productivity and loan default shocks. Three findings emerge. First, the bank's capital requirement has little effect on the international transmission of productivity shocks. Second, the contribution of loan default shocks to business cycle fluctuations is negligible under normal economic conditions. Third, an exceptionally large loan loss originating in one country induces a sizeable and simultaneous decline in economic activity in both countries. This is particularly noteworthy, as the 2007-09 global financial crisis was characterized by large credit losses in the US and a simultaneous sharp output reduction in the US and the Euro Area. Our results thus suggest that global banks may have played an important role in the international transmission of the crisis.
Business cycles, bank credit and crises
Economics Letters, 2013
• We develop a model of bank lending and risk taking in a dynamic context. • We argue that economic volatility can drive the dynamics and stability of credit.
Credit Cycles and Business Cycles
Review, 2018
Two prominent characteristics of the business cycle are the high autocorrelations of credit and output time series and the strong cross-correlation between those two statistics. Understand ing these correlations, without the help of large and persistent shocks to the productivity of financial intermediaries and to the technical efficiency of final goods producers, has been a long-standing goal of macroeconomic research and the motivation for the seminal contributions mentioned in Section 2. Is it possible that cycles in credit, factor productivity, and output are not the work of large and persistent productivity shocks that afflict all sectors of the economy simultaneously? Could these cycles instead come from shocks to people's confidence in the credit market? This article gives an affirmative answer to both questions within an economy in which part of the credit firms require to finance investment is secured by collateral and the remainder Unsecured firm credit moves procyclically in the United States and tends to lead gross domestic product, while secured firm credit is acyclical. Shocks to unsecured firm credit explain a far larger fraction of output fluctuations than shocks to secured credit. This article surveys a tractable dynamic general equilibrium model in which constraints on unsecured firm credit preclude an efficient capital allocation among heterogeneous firms. Unsecured credit rests on the value that borrowers attach to a good credit reputation, which is a forward-looking variable. Self-fulfilling beliefs over future credit conditions naturally generate endogenously persistent business cycle dynamics. A dynamic complementarity between current and future borrowing limits permits uncorrelated belief shocks to unsecured debt to trigger persistent aggregate fluctuations in both secured and unsecured debt, factor productivity, and output. The author shows that these sunspot shocks are quantitatively important, accounting for around half of output volatility. (JEL D92, E32)