Home About Latest Browse RSS Advanced Search

Federal Reserve Bank of Chicago
Working Paper Series
Modeling credit contagion via the updating of fragile beliefs
Luca Benzoni
Pierre Collin-Dufresne
Robert S. Goldstein
Jean Helwege
Abstract

We propose a tractable equilibrium model for pricing defaultable bonds that are subject to contagion risk. Contagion arises because agents with ‘fragile beliefs’ are uncertain about both the underlying state of the economy and the posterior probabilities associated with these states. As such, agents adopt a robust decision rule for updating that leads them to over-weight the posterior probabilities of ‘bad’ states. We estimate the model using panel data on sovereign Euro-zone CDS spreads during the recent crisis, and find that it captures levels and dynamics of spreads better than traditional affine models with the same number of observable and latent state variables.


Download Full text
Cite this item
Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein & Jean Helwege, Modeling credit contagion via the updating of fragile beliefs, Federal Reserve Bank of Chicago, Working Paper Series WP-2012-04, 2012.
More from this series
JEL Classification:
Subject headings:
Keywords: Bonds - Prices ; Europe - Economic conditions ; Eurozone
For corrections, contact Bernie Flores ()
Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal