Default risk analysis via a discrete-time cure rate model

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Abstract

Cure models represent an appealing tool when analyzing default time data where two groups of companies are supposed to coexist: those which could eventually experience a default (uncured) and those which could not develop an endpoint (cured). One of their most interesting properties is the possibility to distinguish among covariates exerting their influence on the probability of belonging to the populations’ uncured fraction, from those affecting the default time distribution. This feature allows a separate analysis of the two dimensions of the default risk: whether the default can occur and when it will occur, given that it can occur. Basing our analysis on a large sample of Italian firms, the probability of being uncured is here estimated with a binary logit regression, whereas a discrete time version of a Cox's proportional hazards approach is used to model the time distribution of defaults. The extension of the cure model as a forecasting framework is then accomplished by replacing the discrete time baseline function with an appropriate time-varying system level covariate, able to capture the underlying macroeconomic cycle. We propose a holdout sample procedure to test the classification power of the cure model. When compared with a single-period logit regression and a standard duration analysis approach, the cure model has proven to be more reliable in terms of the overall predictive performance. Copyright © 2013 John Wiley & Sons, Ltd.

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