Credit Risk, Valuation and Fundamental Analysis

Abstract

This study explores how a rm’s credit risk a¤ects accounting based valuation of the rm, of its equity and of its debt. The valuation model integrates fundamental equity and credit analysis and, under appropriate conditions, abides by the value conservation principle even in the presence of credit risk. The term structures of credit spreads on corporate bonds and credit default swaps are linked to equity valuation and to proforma nancial statements. Calibration of the valuation model to equity and credit market prices is feasible. The model explains how credit risk depresses price to earnings and price to book ratios. Key words: accounting based valuation, credit spreads, corporate bond valuation, equity valuation, default probability. JEL classi cation: G12; G13.