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Measuring Corporate Default Risk$
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Darrell Duffie

Print publication date: 2011

Print ISBN-13: 9780199279234

Published to Oxford Scholarship Online: September 2011

DOI: 10.1093/acprof:oso/9780199279234.001.0001

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Frailty‐Induced Correlation *

Frailty‐Induced Correlation *

Chapter:
(p.49) 6 Frailty‐Induced Correlation*
Source:
Measuring Corporate Default Risk
Author(s):

Darrell Duffie

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780199279234.003.0006

This chapter presents the foundations for frailty modeling of correlated default in a setting of stochastic intensities. The approach is to assume that default times are jointly doubly stochastic given extra information unavailable to the econometrician. This “hidden” information includes covariates that, although not directly observable, have conditional probability distributions that can be filtered from histories of default times and observable covariates. The dependence of default timing on unobservable covariates allows for sources of default correlation beyond those present in the observed covariates. The methodology relies on Markov Chain Monte Carlo (MCMC) techniques, provided in appendices, for evaluating likelihood functions and for filtering or smoothing hidden (frailty) state information.

Keywords:   corporation, default, risk, empirical estimation, default intensity, bankruptcy, default correlation, latent, frailty, Markov Chain Monte Carlo

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