Splitting credit risk into systemic, sectorial and idiosyncratic components



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Chamizo Cana, Álvaro and Novales Cinca, Alfonso (2019) Splitting credit risk into systemic, sectorial and idiosyncratic components. [ Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE); nº 30, 2019, ISSN: 2341-2356 ]

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We provide a methodology to estimate a global credit risk factor from CDS spreads that can be very useful for risk management. The global risk factor (GRF) reproduces quite well the different epis- odes that have affected the credit market over the sample period. It is highly correlated with standard credit indices, but it contains much higher explanatory power for fluctuations in CDS spreads across sectors than the credit indices themselves. The additional information content over iTraxx seems to be related to some financial interest r ates. We first use the estimated GRF to analyze the extent to which the eleven sectors we consider are systemic. After that, we use it to split the credit risk of indi- vidual issuers into systemic, sectorial, and idiosyncratic components, and we perform some analyses to test that the estimated idiosyncratic components are actually firm-specific. The systemic and sec- torial components explain around 65% of credit risk in the European industrial and financial firms and 50% in the North American firms in those sectors, while 35% and 50% of risk, respectively, has an idiosyncratic nature. Thus, there is a significant margin for portfolio diversification. We also show that our decomposition allows us to identify those firms whose credit would be harder to hedge. We end up analyzing the relationship between the estimated components of risk and some synthetic risk factors, in order to learn about the different nature of the credit risk components.

Item Type:Working Paper or Technical Report
Uncontrolled Keywords:Credit Risk; Systemic Risk; Sectorial Risk; Idiosyncratic Risk; Asset Allocation.
Subjects:Sciences > Mathematics > Finance
Social sciences > Economics > Depressions
Social sciences > Economics > World economy
JEL:C58, F34, G01, G32
Series Name:Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE)
ID Code:57380
Deposited On:16 Oct 2019 11:22
Last Modified:17 Oct 2019 11:01

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