Private Credit Risk

Abstract

The investment and financing decisions of a firm are integrally related to its creditworthiness. There are two broad contexts in which these decisions need to be considered, however. The context in which those decisions are made will influence one’s understanding of the determinants and dynamics of credit or default risk. The first approach rests on a vision that investment is a stabilizing activity. This view underlies mainstream economic and finance theory. The other approach rests on a vision that investment is destabilizing, and it underlies the heterodox, nonmainstream approach(es). The implications of the two stances are explored in this chapter for how they explain and assess default or credit risk. By doing so, some of the sources of the malfunctions, which were identified (in the previous chapter) as compromising the quality of ratings, can be identified. Sluggishness, pro-cyclicality, and other methodological issues might better be explained if creditworthiness were assessed in the context of investment as an inherently destabilizing activity, rather than from a perspective in which it is a stabilizing activity. As such, the discussion yields new insights for improving methods of assessing creditworthiness.