Timeliness in Selected Structural Credit Risk Models

We empirically investigate and evaluate various approaches to structurally assess credit risk changes using a panel of selected European banking groups. The objective is to evaluate the models according to one metric, i.e., their ability to correctly and timely identify changes in credit risk indicators useful for macroprudential policy. We consider not only the standard approaches in the literature, but also include models that allow the asset volatility to be stochastic and models that allow for short- and long-term components of default risk. Surprisingly, we find that the GARCH structural credit risk model, despite its more sophisticated modeling approach, typically underperforms more basic models. Importantly for macro-prudential policy, combining the Merton model with the GARCH-MIDAS model performs best and reflects important market events earlier than the other approaches.