Macroeconomic Impact on Expected Default Freqency

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.

Keywords: Expected Default Frequency, Macroeconomic Impact, Business cycle, vector error correction model, Financial stability, Financial and real economy interaction

JEL Classification: C32, C52, C53, G21, G33