Back Matter
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

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1

We especially thank Jin-Chuan Duan and Weimin Miao for insightful discussions and comments, seminar participants at the IMF, and the technical support from the staff at the Credit Research Initiative, Risk Management Institute, National University of Singapore. Insights from IMF economists who pilot-tested BuDA in their policy work have been incorporated here. Any errors and omissions are the authors’ sole responsibility.

3

Sectoral PD series used in the calculation were obtained from the database maintained by the Credit Research Initiative, Risk

Management Institute, National University of Singapore. The database is freely available at rmicri.org upon registration.

4

Most firms report financial statements in local currency with foreign currency denominated debt adjusted for changes in exchange rates. To sum the stock of debt across currencies without introducing the additional impact of foreign exchange fluctuations, nominal debt stocks in local currency are converted to US dollars at fixed 2012 exchange rates. With this adjustment, the analysis focuses on the change in the debt stock (debt burden) and not on the levels.

5

The threshold value of 2 is a commonly used benchmark in the literature.

6

The BuDA methodology was jointly developed by researchers at the Credit Research Initiative at the Risk Management Institute, National University of Singapore (RMI-CRI, NUS), and the International Monetary Fund (Duan, Miao and Chan-Lau, 2015. Recent examples of policy work using this methodology include IMF (2016b, Chapter 3), IMF (2016c, Chapter 2; 2016e, Chapter 2), and IMF (2016d) among others.

7

The median refers to the average median PD value of the sample of non-financial firms analyzed in each country. In the calculations, the average is calculated over 1000 simulations.

8

The term mis-valuation, the term is used in a somewhat generic sense; in an efficient/steady state scenario, market and book value would be similar.

9

The currency denomination mix in corporate debt is not considered separately in the BuDA framework. The model only looks at total debt, as incorporated into several of the firm-specific factors. The effects of currency mismatches on solvency risk is captured indirectly through market movements, via volatility and distance to default.

10

The potential noise from outliers (firms or industries) will be addressed to some extent by using median PDs in the methodology to compute provisions and capital needs.

11

For the analysis, metal prices are proxied by the IMF’s composite price index and the oil price is the simple average of three crude oil spot prices (APSP); aggregate demand of advanced economies is measured by the growth rate of a composite index of advanced economies’ real GDP; external borrowing cost is measured by U.S. dollar short-term rates, (i.e. the U.S. Federal Fund rates), and U.S. dollar long-term rates, (i.e. the U.S. 10-year Treasury bond). All data were sourced from the IMF’s International Financial Statistics and World Economic Outlook databases

13

The scenario assumes severe commodity price declines beyond what the baseline scenario contemplates but short of the realization of a tail event. In this sense, it differs from the type of scenarios central banks and policy making institutions use when they stress test banking systems, as described in Siddique and Hasan (2013), among others.

14

A country-specific Vector Autoregressive (VAR) is used to project the paths of the domestic variables in the distress scenario. The endogenous variables are the real GDP growth rate and the exchange rate, and the exogenous variable is the key export commodity price, which is oil for Colombia and Mexico, and metals for Brazil, Chile, and Peru. The VAR is estimated in first differences to ensure stationarity. To generate the distress scenario for GDP and the exchange rate, we first forecast them conditional on the baseline scenario, and second conditional on the commodity price shocks. The difference between the two forecasts is added to the baseline scenario to obtain the distress scenario.

15

Stronger corporate governance and information disclosure requirements apply to listed firms than to unlisted firms. BuDA’s PD projections, hence, could be interpreted as a lower bound on the PDs of unlisted firms. Though originally developed for publicly listed firms, it is possible to extend the DSW model to include privately held firms not traded in the market, as in Duan, Kim, Kim, Kim, and Shin (2014). Future work will aim to incorporate this feature in the BuDA model.

16

In other words, the proper choice of the regularization parameter allows models estimated using the SCAD penalty to perform as well as if the correct model is known.

Bottom-Up Default Analysis of Corporate Solvency Risk: An Application to Latin America
Author: Mr. Jorge A Chan-Lau, Cheng Hoon Lim, Jose Daniel Rodríguez-Delgado, Mr. Bennett W Sutton, and Melesse Tashu