Shock Models for Defaults: Parametric and Nonparametric Approaches

We review shock models for defaults, both in the standard and in the urn based approach. Shock models are motivated by engineering problems where a material can break because of stress, but they can also be efficiently used in other fields, such as economics and biology. Standard shock models are parametric models, whereas the urn-based shock models are nonparametric models assuming as little as possible for the prediction of defaults. First, we mention some results for the two models, in particular describing the finite and asymptotic behavior of time to failure or of the chance for defaults. Finally, we also present an application of the second model to defaults of Italian firms, comparing our results with a standard prediction model of economics, the Z-score. We note that our model predicts the default behavior of these firms better.