Corporate defaults and large macroeconomic shocks’, mimeo

We explore the impact of possible non-linearties on credit risk in a VAR set-up. We look at two measures of credit risk: quarterly aggregate liquidation rates and quarterly firm specific probability of defaults, which are derived by a new method from annual default data. We show three important results. First, non-linearities matter for the level and shape of impulse response functions of credit risk following small as well as large shocks to systematic risk factors. Second, in the non-linear model the impact of a shock depends significantly on the starting level of exogenous variables. Depending on actual conditions and the forecast horizon, the level as well as the sign of the impact can change. Third, we account for uncertainty in our estimates and show that ignoring this can lead to a substantial underestimation of credit risk, especially in extreme conditions