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The Risks of Financial Institutions$
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Mark Carey and Rene M. Stulz

Print publication date: 2007

Print ISBN-13: 9780226092850

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226092980.001.0001

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PRINTED FROM CHICAGO SCHOLARSHIP ONLINE (www.chicago.universitypressscholarship.com). (c) Copyright University of Chicago Press, 2021. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in CHSO for personal use.date: 17 September 2021

Global Business Cycles and Credit Risk

Global Business Cycles and Credit Risk

(p.419) 9 Global Business Cycles and Credit Risk
The Risks of Financial Institutions

M. Hashem Pesaran

Til Schuermann

Björn-Jakob Treutler

University of Chicago Press

This chapter presents evidence of considerably larger benefits of credit diversification than are implied by current workhorse models. The global vector autoregressive macroeconometric model presents forecasts of all the global variables that directly or indirectly affect the returns. Changes in equity prices, interest rates, and oil prices remain the key driving factors in multifactor regressions. Heterogeneity is vital in controlling risk, both under a baseline forecast and under shock scenarios. Full firm-level parameter heterogeneity matters a great deal for capturing differences in simulated credit loss distributions. The shape of the loss distribution is significantly influenced under neglected heterogeneity, in which case the resulting pricing and risk assessment would in turn be significantly affected. It is shown that the size of the portfolio needed to eradicate most of the idiosyncratic risk, and thus fully exploit the diversification potential that exists in credit portfolios, may be in the thousands.

Keywords:   credit diversification, workhorse models, equity prices, interest rates, oil prices, heterogeneity, credit loss distributions, idiosyncratic risk

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