Unobserved components in corporate defaults and bond prices
نویسندگان
چکیده
If there is an unobserved component in corporate default intensities, then part of the fluctuation in corporate bond prices can be attributed to the variation in beliefs about this latent factor over time. Using sequential Markov Chain Monte Carlo techniques, we show evidence of a latent frailty process in the default intensities in U.S. corporate defaults. The factor is robust to the inclusion of both macro and firm specific variables. We use the sequentially estimated changes in conditional expectations of the frailty level, persistence and volatility to proxy for changes in agents’ beliefs about the unobserved default intensities. We find that changes in frailty related variables help to explain the variation in U.S. corporate credit spreads and increase explanatory power by 10%–22%.
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