A Flow-Based Corporate Credit Model

Abstract

This study develops a flow-based corporate credit model that is able to generate concurrently and endogenously a firm’s multi-period probabilities of liquidity crunch and expected liquidity shortfalls. Based upon a state-dependent internal liquidity model, it incorporates both systematic and idiosyncratic shocks into corporate internal liquidity dynamics. It is different from structural form credit models in that it considers a flow-based insolvency rather than a stock-based one, and has a potential to capture short-term credit information. Additionally, it is different from both reduced form and traditional accounting-based bankruptcy prediction models in that it is able to provide multi-period expected liquidity shortfalls endogenously.