Measure Of Default Risk Research Articles

Reduced disclosure and default risk: analysis of smaller reporting companies

We examine the causal effect of reduced disclosure levels on the risk of default. Employing regression discontinuity (RD) design as our main identification strategy and the smaller reporting company rule (SRC rule) as the exogenous source of variation, we show that smaller reporting companies (SRCs), which are permitted to provide scaled disclosures in their 10-Ks, experience significantly and economically higher default risk. We demonstrate that, while there is no effect of information loss if a smaller reporting company voluntarily maintains its disclosure level by continuing to report its financial performance in full, there is an increase in its default risk due to the loss of commitment to mandatory disclosure. We also find that, compared to previously qualified SRCs, newly qualified smaller reporting companies face steeper increases in bankruptcy risk during their first year of eligibility. Our analysis indicates that strong external oversight mechanisms, better corporate governance, and credible audit quality attenuate the negative impact of reduced disclosure levels on the risk of default. Our results are robust to alternative model specifications, RD design assumptions, and measures of default risk.

An axiomatic approach to default risk and model uncertainty in rating systems

In this paper, we deal with an axiomatic approach to default risk. We introduce the notion of a default risk measure, which generalizes the classical probability of default (PD), and allows to incorporate model risk in various forms. We discuss different properties and representations of default risk measures via monetary risk measures, families of related tail risk measures, and Choquet capacities. In a second step, we turn our focus on default risk measures, which are given as worst-case PDs and distorted PDs. The latter are frequently used in order to take into account model risk for the computation of capital requirements through risk-weighted assets (RWAs), as demanded by the Capital Requirement Regulation (CRR). In this context, we discuss the impact of different default risk measures and margins of conservatism on the amount of risk-weighted assets.

Analyst coverage, executive compensation and corporate risk‐taking: Evidence from property–casualty insurance firms

AbstractUsing an exogenous drop in analyst coverage introduced by broker closures and mergers, we test for the causal impact of analyst coverage on corporate risk‐taking, in an opaque industry. We document an increase in risk using several book‐based and market‐based risk measures, including tail and default risk measures. Results are driven by firms with stronger managerial risk‐taking compensation incentives. The increase in risk is stronger in more opaque firms, and firms with weaker policyholder monitoring. Firm risk increases through at least one risk‐taking action, such as investing firm assets in higher‐risk bonds. Our study highlights the importance of stock analysts in affecting corporate risk‐taking, especially in the presence of stronger managerial, compensation risk‐taking incentives.

Female CEOs and default risk in listed family firms

PurposeThe purpose of this paper is to examine the effect of female CEO board members on listed family firms’ corporate default risk, integrating upper echelons theory with social role theory and the socio-emotional wealth approach and proxying default risk with the Black–Scholes–Merton model. It also searches for possible differences attributable to the type of female CEO.Design/methodology/approachThis study is applied to a longitudinal sample of listed US family firms. After a preliminary analysis of the main descriptive, several models are estimated with the system GMM estimator, which is a panel data estimator. The models are dynamic, including the lagged value of the dependent variable. In addition, the model estimation is repeated with a different measure of default risk, for robustness.FindingsThis research findings show that default risk diminishes in the presence of a female CEO, whose reduction is even greater if she is a family member. The results are proven to be robust to the measure for proxying default risk.Originality/valueThis study primarily contributes to the existing literature by exploring a possible link between female CEOs, particularly those with a family affiliation, and a lower level of default risk in family firms. It also provides practical implications for policymakers, who would be advised to promote conditions enabling women to contribute towards family business viability. In addition, this study offers encouragement for family business owners to value the potential of their female family members in company succession processes.

Fighting depopulation in Europe by analyzing the financial risks of local governments

Throughout Europe, one of the main problems facing policymakers is that of falling rural populations. In many cases, this is aggravated by high levels of local government borrowing. Although researchers have sought to determine the causes of this debt, much remains to be known about the factors influencing the default risk of small- and medium-sized towns, information that would help them formulate policies to combat the loss of population. The aim of our study is to identify factors relevant to this default risk. We analyzed demographic, socioeconomic, and financial factors in a sample of 6456 Spanish local governments by their population size. Our findings show that financial policies applied to reduce this risk should vary according to the population size, as certain factors exert a specific influence on smaller municipalities. Nevertheless, socioeconomic and financial variables have more impact on default risk than demographic factors. Our findings are novel and useful for all concerned in combating the depopulation of rural areas in Europe, owing to the relevance of conclusions for the design of public policies based on the sustainability of public services in small municipalities. Points for practitioners The measurement of the default risk in local governments reveals very relevant information for the design of public policies against depopulation. Socioeconomic and financial variables have more impact on default risk than demographic factors. The evolution of the measurement of default risk reveals that policies against depopulation must be defined based on the size of the municipalities. The influencing factors on the default risk are interesting to decide if finance government investments through loans that allow the repopulation of small municipalities.

An Empirical Study on the Relationship between Corporate Social Responsibility and Default Risk: Evidence in Korea

Focusing on the Korean stock market, this paper expands on previous research on the relationship between corporate social responsibility (CSR) and default risk. By using a comprehensive sample of 6977 firm-year observations during the 2011–2021 period, we employ the year fixed effects and industrial sector dummies classified by FnGuide Industry Classification Standard to control for shifting economic conditions over time and effects within industries. The Z-score is employed as the primary proxy for default risk, and the finding of the study confirms a negative association between CSR practices and default risk. Moreover, testing the three components of CSR, we also find that each component has a negative impact on the default risk. To ensure the robustness of our findings, we conduct a robustness check using two additional proxies of default risk: the K-score, a specific measure of default risk for the Korean market, and the distance to default (DTD), a market-based model. Our results remain consistent and robust even when utilizing alternative proxies, further confirming the negative relationship between CSR and default risk. This has significant implications for businesses and regulators who aim to decrease the risk of default through implementing CSR initiatives.

Benchmarking the effects of the Fed's Secondary Market Corporate Credit Facility using Yankee bonds

We use foreign issuers' “Yankee” bonds to benchmark how the Federal Reserve's Secondary Market Corporate Credit Facility (SMCCF) impacted U.S. issuers' bonds of the same credit rating and maturity. The SMCCF reduced the relative yield spreads of short-maturity U.S. investment-grade bonds, which were targeted by the facility. Yet it also decreased the relative yield spreads of U.S. long-maturity AA- and A-rated bonds. Moreover, relative spreads of U.S. BB-rated bonds rose, indicating that the SMCCF harmed these bonds. Using various illiquidity and default risk measures, we find that the SMCCF affected both the relative illiquidity and default risk of U.S. bonds.

Does the threat of takeover affect default risk?

AbstractWe examine the impact of the threat of takeovers on default risk. Using a sample of 50,189 firm‐year observations for US firms over the period 1990–2015, we find that the threat of takeovers has a negative relation with default risk. We use difference‐in‐difference analysis to address potential endogeneity concerns and propensity score matching to control for self‐selection bias. The results are robust to alternative measures of default risk and exclusion of the dot com and financial crisis periods. Our results also hold after controlling for Governance Index and Entrenchment Index. We identify improvement in performance and earnings quality in response to the threat of takeovers as channels underlying our main result. The effect of the threat of takeovers on default risk is more pronounced for firms with opaque information environment and low institutional ownership. Our findings provide important insights for the market for corporate control as a disciplining mechanism in reducing default risk.

Adverse selection in the market for mortgage servicing rights

Transfer activity in the U.S. market for mortgage servicing rights has increased in recent years. Incumbent servicers are at an informational advantage relative to potential buyers of these servicing rights, introducing the possibility of adverse selection. This paper marks the first investigation of adverse selection in the market for mortgage servicing rights. Using data from mortgage servicers, we find that loans with higher ex ante measures of prepayment and default risk were more likely to experience a servicing transfer. Results from an ex post analysis in which we condition on these risk measures reveals that loans that experienced a servicing transfer were more likely to prepay and default, a finding that suggests that the market for servicing rights is characterized by adverse selection.

On the information content of credit ratings and market-based measures of default risk

We examine the ability of ratings and market-based measures to predict defaults. Although market-based measures are more accurate at horizons up to one year, ratings complement market-based measures and are not redundant in predicting defaults across horizons. Market-based measures differ from ratings in that they respond to both cash-flow and discount-rate news, while ratings respond primarily to cash-flow news, which is more informative of future defaults. Ratings ignore transitory shocks to credit risk, while market-based measures do not. Rating agencies respond to transitory shocks with watches rather than downgrades. Ratings are more informative during expansions and for speculative grade firms.

Credit default risk in Islamic and conventional banks: Evidence from a GARCH option pricing model

An important question in banking is whether restrictions placed on Islamic banks make them more resilient to financial market turmoil and less prone to failure than conventional banks. We evaluate this claim by estimating credit default risk measures for a sample of conventional and Islamic banks using a GARCH option pricing model. Using a daily data set that is better suited for the time variation in volatility, we calculate distance to default measures to evaluate credit risk of Conventional Banks (CBs) and Islamic banks (IBs). We find higher default risk measures for IBs than CBs in general except during the Global Financial Crisis. This result holds true after controlling for bank and country specific variables in that IBs seem to have significantly lower default risk during the Global Financial Crisis and higher default risk thereafter. Consequently, while restrictions on risk taking is advantageous in financial turmoil episodes, the same restrictions expose IBs to risks in normal times. Finally, the credit risk of CBs and IBs is negatively affected by the oil crisis in 2014–2015 and the Covid-19 global pandemic. While there is no significant difference between the effects of the oil crisis on IBs versus CBs, the recent Covid-19 pandemic seems to have worsened the credit risk of IBs compared to CBs.

Carbon emissions and default risk: International evidence from firm-level data

In this study, we investigate the effect of carbon emissions on firms' default risk. While existing literature exhibits the implications of emissions for firm performance and value, little is known about its impact on the default risk and underlying economic channels of the impact. Using a panel dataset of 2785 unique firms over the period 2004–2018 from 42 economies, we document a significant and negative impact of emissions on firms' distance-to-default, a reverse measure of default risk. We also provide evidence that firms’ environmental commitments and green initiatives mitigate the effect of emissions on default risk while environmental controversies exacerbate the effect. Finally, we identify the ROA and cash flow volatility as potential channels through which emissions affect the default risk. Overall results suggest that credit risk implications of firm-level emissions are worth considering in policy decisions by relevant stakeholders.

Fresh evidence on the relationship between market power and default risk of Indian banks

In a uniquely designed empirical set-up involving a large set of Indian banks, this study establishes the relationship between market-based measures of default risk represented by Distance-to-Default (DD) and Distance-to-Capital (DC), and the market power reflected through the efficiency-based Lerner index. The results exhibit an inverse relationship between bank market power and bank default risk. Gross Nonperforming Assets (GNPAs), economic growth, and stock market volatility appear as other significant determinants of bank default risk. In the Indian context, this is the first study that utilizes a bank risk measure that incorporates the capital adequacy thresholds embedded under the revised Prompt Corrective Action (PCA) framework.

Default Risk and Stock Returns: Evidence from Indian Corporate Sector

Default risk is associated with the probability that a leveraged firm is not able to pay its financial obligation on time. Relationship between default risk and stock returns is very important from investor’s point of view because it has important implication for risk and return trade off. Relationship between default risk and returns is debatable issue and contradictory results are found in the literature regarding the relationship between default risk and stock returns. Default risk assessment helps the investors and lenders to accurately assess the risks to which investors or lenders are exposed. There are several models which can be used to assess the probability of default. In the present study, the widely used Altman’s Z-score model is used as a measure of default risk to find out the relationship between default risk and stock returns using simple linear regression analysis. It is found that Altman’s Z-score can be used as a measure of default risk and results indicate the existence of positive relationship between Z-score and stock return and hence a negative relationship between default risk and stock return.

Is Doing Good, Good for Business: The Effect of Corporate Rating Analysts’ Corporate Bias on Investor Reactions to Changes in Social Responsibility

In this study, we explore how investors reconcile information on firms’ social responsibility with analysts’ assessments of future firm risk in share pricing. We ask whether investors pay attention to small strides toward and/or small slips away from socially responsible behavior, arguing that analysts’ corporate bias toward gains and against losses influences investor reactions to corporate social responsibility. We hypothesize that analysts notice and reward improvements in social responsibility, yet excuse lapses. We find support for this hypothesis, using a unique dataset of the sample of eighteen firms that appeared within the 2013 KSE 100 index for 5 years (2014–2018). We also collected firm-level social responsibility disclosures data through content analysis of selected companies' annual reports. We also gather share-specific data of risk of default and pricing from rating agencies. Results suggested better CSR disclosures seem to positively affect returns. Surprisingly, higher-risk companies also enjoy higher returns. Moreover, according to expectations, market risk like beta and default risk measures like debt to equity ratio seems to decrease stock returns, whereas ROA seems to have a positive effect. Interestingly smaller size companies enjoy higher returns. We also found robust evidence that when firms increase the amount of good that they do (i.e., their social performance improves), analysts reward them with improved risk ratings. Yet, we also note an asymmetrical effect: analysts do not punish, and investors do not respond to, decreases in social responsibility. In short, analysts seem to be subject to a strongly positive corporate bias when interpreting corporate social responsibility performance. This bias prompt analyst to improve risk ratings when social responsibility improves but resist worsening risk ratings when social responsibility declines. Other findings suggested that default risk decreases more with a higher level of risk, higher debt to equity ratio also seems to cause an increase in growth of default risk, ROA also seems to cause a decrease in default risk. Results also suggested the inclusion of independent directors seems to decrease the default risk. A decrease in default risk also seems to have a positive effect on returns. Our findings elaborate earlier behavioral research on how corporate bias influences analysts’ assessments of risk. As a result, firms may come to understand that they merely must start social responsibility projects to gain the cost of capital benefits—they need not follow through with them. Second, investors may find that relatively minor decreases in social responsibility accumulate over time to constitute quite substantial risks— but they will not be forewarned about these risks because analysts ignore them, and as a result, they will have failed to raise their yield expectations commensurate with these escalating risks. Hence, our work motivates more critical scrutiny of the role analysts plays in revising the future risk of today’s social action versus inaction.

News-Implied Sovereign Default Risk

We develop a novel real-time measure of sovereign default risk using natural language processing and implement it using 10 million news articles covering over 100 countries. Our News-implied Sovereign Risk Index (NSRI) is a high-frequency measure of countries' default risk, particularly for those lacking market-based measures: NSRI correlates with sovereign CDS spreads, predicts rating downgrades, and reflects default risk information not fully captured by CDS spreads. We assess the influence of sovereign default concerns on equity markets and find that spikes in NSRI are negatively associated with same-week market returns, which reverses over the next week, indicating that investors might overreact to default risk news. Equity markets' reaction to default concerns is more pronounced and persistent for countries with tight fiscal constraints. The reaction to global, compared to country-specific, default concerns is much stronger, underlining the relevance of global push factors for local asset prices.

Dependent Credit Default Risk Modelling Using Bernoulli Mixture Models

Generalized Linear Mixed Models (GLMMs) can be used to model the occurrence of defaults in a loan or bond portfolio. In this paper, we used a Bernoulli mixture model, a type of GLMMs, to model the dependency of default events. We discussed how Bernoulli mixture models can be used to model portfolio credit default risk, with the probit normal distribution as the link function. The general mathematical framework of the GLMMs was examined, with a particular focus on using Bernoulli mixture models to model credit default risk measures. We showed how GLMMs can be mapped into Bernoulli mixture models. An important aspect in portfolio credit default modelling is the dependence among default events, and in the GLMM setting, this may be captured using the so called random effects. Both fixed and random effects influence default probabilities of firms and these are taken as the systemic risk of the portfolio. After describing the model, we also conducted an empirical study for the applicability of our model using Standard and Poor’s data incorporating rating category (fixed effect) and time (random effect) as components of the model that constitute to the systemic risk of the portfolio. We were able to find the estimates of the model parameters using the Maximum Likelihood (ML) estimation method.

Performance of default-risk measures: the sample matters

This paper has been possible thanks to the SANFI Research Grant for Young Researchers Edition 2015, the financial support from the Spanish Ministry of Economy, Industry and Competitiveness (ECO2016-77631-R (AEI/FEDER, UE)) and the Spanish Ministry of Science and Innovation (PID2019-104304GB-I00/AEI/10.13039/501100011033). Ana Gonzalez Urteaga particularly acknowledges financial support from the Spanish Ministry of Science, Innovation and Universities through grant PGC2018-095072-B-I00.

Measuring credit risk in family firms

This article attempts to identify the default risk measure which best reflects the idiosyncratic context of public family firms. Seven accounting- and market-based measures are compared over a sample of 981 US family and non-family firms for the period 2000–2016. The results show that the Black–Scholes–Merton (BSM) measure gives the best fit in both types of firm. However, all the accounting-based measures, especially Altman’s Z-score, come closest to the market-based measures when used to assess the credit risk of family firms. The two types of measures also coincide more closely in their default risk orderings of family than of non-family firms. Useful practical implications can be drawn from these findings, which show that accounting-based measures can be used reliably in the absence of market data for family firms with similar characteristics to those in our sample. JEL CLASSIFICATION: G32; G33; G13; C52; M21; M41

The Uncertainty of Credit Safety

Credit grades are ordinal measures of default risk that are used to rank the relative creditworthiness of different borrowers rather than the relative safety of different environments. They are assigned by specialized rating agencies, which face short-term pressures to fudge their rankings and long-term pressures to nurture a reputation for insight and objectivity. Their biggest analytic challenge is to find enough data with enough explanatory power to justify their rankings. For quantitative modeling, credit grades are best viewed as multipliers on a fluctuating aggregate default risk . Experience shows that the scale is roughly logarithmic, with each full-letter drop in credit grade roughly quadrupling the default risk. The regularities suggest that credit grades are usually assigned correctly or near-correctly. However, the pool of relevant servicing history is not always large enough to measure high safety well. The triple-A grade should arguably be dropped and most tiering of A-grade sovereign credits ended. However, this need not coarsen overall ratings. Instead, ratings agencies should be encouraged to offer a second dimension of rating geared to perceived stability. A highly stable double-A rating would offer everything a triple-A rating does. For long bonds from A-grades, higher rated stability might be more valuable than a higher grade.