Credit Quality Correlation Structure in the Emerging Markets

One-factor models claim, that credit quality of a firm is determined by some general factor (e.g. country condition) and individual factors. Further models expand the list of common factors, and introduce, e.g., industry condition as the common factor that drives credit quality correlation. The purpose of this study is to test the hypothesis, that the firms form credit quality correlation clusters based on the industry factor, and to find out, if there are better grouping criteria. Using Russian bond market data from 09.11.2003 till 14.06.2008 and after accounting for the country risk factor, if was found that on the Russian market there is no evidence of clusterization based on the industry factor or degree of state ownership. In both cases average correlation remains low. However the stable cluster with high average correlation can be found, which consists of the biggest gas and oil companies and some state owned firms. Principal Components Analysis was used to extract the country risk factor.