Estimating volatility clustering and variance risk premium effects on bank default indicators

Default risk increases substantially during financial stress times due to mainly the two reasons: volatility clustering and investors’ desire to protect themselves from such increases in volatility. It manifested in the aftermath of the Global Financial Crisis of 2008–2009 with unpleasant outcomes o...

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Bibliographic Details
Published inReview of quantitative finance and accounting Vol. 57; no. 4; pp. 1373 - 1392
Main Authors Kenc, Turalay, Cevik, Emrah Ismail
Format Journal Article
LanguageEnglish
Published New York Springer US 01.11.2021
Springer Nature B.V
Subjects
Accounting/Auditing
Clustering
Corporate Finance
Credit risk
Default
Econometrics
Economic crisis
Economic stress
Economics and Finance
Finance
International finance
Operations Research/Decision Theory
Original Research
Psychological distress
Risk exposure
Risk premiums
Unpleasant
Volatility
GARCH option pricing
Structural credit risk
Banking
G21
G01
G28
Variance risk premiums
Default risk
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Summary:Default risk increases substantially during financial stress times due to mainly the two reasons: volatility clustering and investors’ desire to protect themselves from such increases in volatility. It manifested in the aftermath of the Global Financial Crisis of 2008–2009 with unpleasant outcomes of many bankruptcies and severe financial distress. To account for these features, we adapted the structural credit risk approach to include both time-varying (return) volatility and risk premium about the return volatility itself. By applying the model to US banks, we obtain better bank default indicators in comparison to the benchmark models.
ISSN:0924-865X
1573-7179
DOI:10.1007/s11156-021-00981-6