Default Correlations In China's Stock Market

Modeling correlated default risk is a new phenomenon currently sweeping through the credit markets. Laking of credit rating companies like Moody or Standard & Poor providing comprehensive risk management services, without data set of default probabilities (PDs) about the firms in the stock market of China, we use the stock prices of 113 firms, and the public rating information about these firms coming from Shanghai Far East Credit Rating Co.,LTD, to calculate their PDs of time series. We convert PDs into hazard rates using an assumption of constant hazard rates. Using the total hazard rate (THR) across issuers at each point in time as calculated, we graph the exceedance correlations for the different rating classes, and analyse three features of default correlation: correlation levels, correlation asymmetry, and tail-dependence. The exceedance plot shows that stocks within high quality ratings have greater default correlation than stocks within low quality ratings. However, tail dependence is higher for lower rated stocks. Both results are intuitive – high grade debt tends to be issued by large firms that experience greater amounts of systematic risk, and low grade firms evidence more idiosyncratic risk; however, when economy-wide default risk escalates, low grade bonds are more likely to experience contagion, leading to greater tail dependence. There is clear evidence of correlation asymmetry, so we conclude that we can't model default correlation under the assumption of symmetry. At last in this paper, we also give some advises how to complete the credit rating job in China.