Default probability estimation via pair copula constructions

•We provide a methodology to accurately evaluate firm default probability.•Multivariate contingent claim model on balance sheet data for firm asset value.•Use of Bayesian parametric mixture models for vine-marginal modelling.•Asset and liability dependence structure is modelled via pair copula const...

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Bibliographic Details
Published in:European journal of operational research 2016-02, Vol.249 (1), p.298-311
Main Authors: Dalla Valle, Luciana, De Giuli, Maria Elena, Tarantola, Claudia, Manelli, Claudio
Format: Article
Language:English
Subjects:
Default
Default probability
Estimating techniques
Markov chain Monte Carlo
Monte Carlo simulation
Multivariate contingent claim
Pair copula
Probability
Studies
Vines
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Summary:•We provide a methodology to accurately evaluate firm default probability.•Multivariate contingent claim model on balance sheet data for firm asset value.•Use of Bayesian parametric mixture models for vine-marginal modelling.•Asset and liability dependence structure is modelled via pair copula constructions.•Our approach allows us to correctly estimate the PD of defaulted as well as of sound firms. In this paper we present a novel approach for firm default probability estimation. The methodology is based on multivariate contingent claim analysis and pair copula constructions. For each considered firm, balance sheet data are used to assess the asset value, and to compute its default probability. The asset pricing function is expressed via a pair copula construction, and it is approximated via Monte Carlo simulations. The methodology is illustrated through an application to the analysis of both operative and defaulted firms.
ISSN:0377-2217
1872-6860
DOI:10.1016/j.ejor.2015.08.026