Determinants of Corporate Default: Systematic Distress, Sectoral Distress and Credit Contagion

This paper studies the effects of systematic distress and sectoral distress in the context of default/bankruptcy prediction using a large sample of U.S. public company default data from 1991 to 2009. I construct measures to proxy for economy-wide systematic distress and sectoral distress based on distance to default, which is a powerful proxy to evaluate a firm's credit risk. I find that including such distress factors as covariates can improve the intensity model's performance to predict defaults. Therefore the systematic and sectoral distress factors are important macroeconomic and industry-level covariates that are missing in the previous literature. I also examine the credit contagion effects using the Hawkes specification. Contrary to Lando and Nielson (2010), I find strong evidence that credit contagion effects do exist in the sample. After adding the systematic and sectoral distress factors to such model, the credit contagion effects are much less significant which indicates that these distress measures are able to capture the pre-default as well as post-default contagion effects.