Econometric Methods for Sector Analysis

Default event correlation and dependency plays a key role in determining portfolio credit risk. We present two econometric methods that can be employed to forecast default rates and describe correlations of the forecasts. The first approach is company-specific, based on a Merton-style threshold model. The second focuses on the systematic risk factors influencing the obligors of a specific industry or country. Both approaches are particularly well suited to estimating default rate development and correlation in a conditional independence framework such as CreditRisk+. Based on panel data covering a variety of countries and industries we present an implementation example for the second method of seemingly unrelated regression and illustrate the implications of dynamic and correlated default rates on the risk of a large portfolio of credits.