Macroeconomic Impact on Expected Default Frequency

[Sapphire Capital]

Macroeconomic Impact on Expected Default Frequency

Per Åsberg Sommar
Sveriges Riksbank - Financial Stability

Hovick Shahnazarian
Sveriges Riksbank - Financial Stability


November 2008

Riksbank Research Paper Series No. 51
Riksbank Working Paper No. 220

Abstract:
We use a vector error correction model to study the long-term relationship between aggregate expected default frequency and the macroeconomic development, i.e. CPI, industry production and short-term interest rate. The model is used to forecast the median expected default frequency of the corporate sector by conditioning on external forecasts of macroeconomic developments. Evaluations of the model show that it yields low forecast errors in terms of RMSE. The estimation results indicate that the interest rate has the strongest impact on expected default frequency among the included macroeconomic variables. The forecasts indicate that EDF will rise gradually over the forecast period.

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