The Determinants of Default Correlations
نویسندگان
چکیده
This paper analyses the ability of some structural models to predict corporate bankruptcy. The study extends the existing empirical work on default risk in three ways. First, it estimates the expected default probabilities and computes default correlations using a copula function for a sample of bankrupt in the US. Second, it extracts common or latent factors that drive companies’ default correlations using a factor-analytical technique. The results indicate that the common factors, which capture the overall state of the economy, explain default correlations. Information-related tests corroborate the results of prediction-orientated tests reported by other studies in the literature; however, only a weak explanatory power is found in the widely used market-to-book assets and book-to-market equity ratio. Idiosyncratic risk observed to change significantly prior to bankruptcy implying that financial markets also react to company specific signals.
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