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Business and Default Cycles for Credit Risk

Author

Listed:
  • Siem Jan Koopman

    (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)

  • André Lucas

    (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)

Abstract
This discussion paper led to an article in the Journal of Applied Econometrics (2005). Vol. 20, issue 2, pages 311-323. Various economic theories are available to explain the existence of credit and default cycles. There remains empirical ambiguity, however, as to whether or these cycles coincide. Recent papers_new 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 1927-1997 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 from business cycles. It turns out that cyclical co-movements arise between default rates, but not real GDP. There is, however, a contemporaneous correlation between real GDP and default rates. Regarding the longer term evolution of the series, credit spreads influence default rates and real GDP, but not vice versa. This corroborates some of the empirical findings in the recent literature on the correlation between macrovariables and default rates. It also suggests the use of credit spreads besides or instead of economic growth rates to forecast the dynamics of future default rates.

Suggested Citation

  • Siem Jan Koopman & André Lucas, 2003. "Business and Default Cycles for Credit Risk," Tinbergen Institute Discussion Papers 03-062/2, Tinbergen Institute, revised 09 Jan 2003.
    • Handle: RePEc:tin:wpaper:20030062
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    References listed on IDEAS

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    More about this item

    Keywords

    credit cycles; business cycles; defaults; credit risk; procyclicality; multivariate unobserved component models.;
    All these keywords.

    JEL classification:

    • C19 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Other
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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