Modeling credit contagion via the updating of fragile beliefs

Luca Benzoni, Pierre Collin-Dufresne, Robert S. Goldstein () and Jean Helwege
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Robert S. Goldstein: https://carlsonschool.umn.edu/faculty/robert-goldstein

No WP-2012-04, Working Paper Series from Federal Reserve Bank of Chicago

Abstract: We propose a tractable equilibrium model for pricing defaultable bonds that are subject to contagion risk. Contagion arises because agents with ?fragile beliefs? are uncertain about both the underlying state of the economy and the posterior probabilities associated with these states. As such, agents adopt a robust decision rule for updating that leads them to over-weight the posterior probabilities of ?bad? states. We estimate the model using panel data on sovereign Euro-zone CDS spreads during the recent crisis, and find that it captures levels and dynamics of spreads better than traditional affine models with the same number of observable and latent state variables.

Keywords: Bonds - Prices; Europe - Economic conditions; Eurozone (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-cba and nep-mon
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Citations: View citations in EconPapers (12)

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Related works:
Journal Article: Modeling Credit Contagion via the Updating of Fragile Beliefs (2015)
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