AN EMPIRICAL ANALYSIS OF CORPORATE DEFAULT RISK DURING THE FINANCIAL CRISIS OF 2007-2009

Abstract

This paper investigates the sharp increase in corporate bankruptcies during the financial crisis of 2007-2009. The primary question explored is whether firms faced industry-level shocks to corporate bankruptcy risk in a way that can be understood through proximity to the housing and credit markets. Much of the research on bankruptcy risk to date has focused exclusively on idiosyncratic firm characteristics such as liquidity, leverage, and profitability. This paper uses a multi-period logit model based on panel data and introduces a crisis dummy variable in interaction terms to distinguish between the crisis period (3Q 2007 to 2Q 2009) and a pre-crisis period (3Q 2005 to 2Q 2007). The logit evidence suggests that the increase in corporate bankruptcy risk was driven largely by industry-level shocks in a way that was not observed prior to the crisis. Industries with greater proximity to the credit and housing markets (e.g., Finance, Insurance, and Real Estate and Construction) appeared to be disproportionately affected. In addition, I find that firms in those industries became more sensitive to changes in liquidity, leverage, and profitability.