Examining What Best Explains Corporate Credit Risk: Accounting-Based versus Market-Based Models

Antonio Trujillo-Ponce,Reyes Samaniego-Medina,Clara Cardone-Riportella

doi:10.2139/ssrn.2072176

Abstract

This paper uses a sample of 2,186 credit default swap (CDS) spreads quoted in the European market during the period 2002–2009 to empirically analyze which model – accounting- or market-based – better explains corporate credit risk. We find little difference in the explanatory power of these two approaches. Our results indicate that a comprehensive model that combines accounting- and market-based variables is the best option to explain the credit risk, suggesting that both types of data are complementary. We also demonstrate that the explanatory power of credit risk models is particularly strong during periods of high uncertainty, such as those experienced in the recent financial crisis. Finally, the comprehensive model continues to produce the best results if the credit rating is used as the proxy for credit risk; however, accounting variables currently appear to have a more important role than market variables in determining corporate credit ratings.

Highlights

The ability of investors or potential lenders to correctly measure the credit risks of companies is an issue that has historically attracted attention in the financial literature
We find little difference in the explanatory power of these two approaches
Our results indicate that a comprehensive model that combines accounting- and market-based variables is the best option to explain the credit risk, suggesting that both types of data are complementary

Summary

Introduction

The ability of investors or potential lenders to correctly measure the credit risks of companies is an issue that has historically attracted attention in the financial literature. The use of credit risk models has been fully established in the literature since 1966, when Beaver published his pioneering work, ‘Financial ratios as predictors of failure’ in Journal of Accounting Research, which served as a reference for subsequent investigations. The use of credit risk models has been fully established in the literature since 1966, when Beaver published his pioneering work, ‘Financial ratios as predictors of failure’ in Journal of Accounting Research, which served as a reference for subsequent investigations1 This univariate model was followed by a multidimensional-type model that integrates all of the relevant variables that contribute to the success or failure of a company and provides a single diagnosis or overall assessment of their creditworthiness. These models both use information drawn from the financial statements of borrowers and are known as accountingbased models

Methods

Results

Conclusion