A Causal Framework for Credit Default Theory

Australian Prudential Regulation Authority Working Paper

30 Pages Posted: 3 Feb 2014

See all articles by Wilson N. Sy

Wilson N. Sy

Investment Analytics Research

Date Written: October 18, 2007

Abstract

Most existing credit default theories do not link causes directly to the effect of default and are unable to evaluate credit risk in a rapidly changing market environment, as experienced in the recent mortgage and credit market crisis. Causal theories of credit default are needed to understand lending risk systematically and ultimately to measure and manage credit risk dynamically for financial system stability. Unlike existing theories, credit default is treated in this paper by a joint model with dual causal processes of delinquency and insolvency. A framework for developing causal credit default theories is introduced through the example of a new residential mortgage default theory. This theory overcomes many limitations of existing theories, solves several outstanding puzzles and integrates both micro and macroeconomic factors in a unified financial economic theory for mortgage default.

Keywords: Causal framework, credit default risk, delinquency, insolvency, mortgage default

JEL Classification: B41, C81, D14, E44, G21, G32, G33

Suggested Citation

Sy, Wilson N., A Causal Framework for Credit Default Theory (October 18, 2007). Australian Prudential Regulation Authority Working Paper, Available at SSRN: https://ssrn.com/abstract=2389605 or http://dx.doi.org/10.2139/ssrn.2389605

Wilson N. Sy (Contact Author)

Investment Analytics Research ( email )

12 Gilchrist Place
Balmain East, NSW 2041
Australia
0424669802 (Phone)

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