Measure Of Default Risk Research Articles

Is default risk the hidden factor in momentum returns? Some empirical results

AbstractThis paper analyzes the role of default risk in the momentum effect focusing on data from four developed European stock markets (France, Germany, Spain and the United Kingdom). Using a market‐based measure of default risk, we show that it is not the hidden factor behind this effect. While the loser portfolio is characterized by high default risk, small size, high book‐to‐market and illiquidity, characterization of the winner portfolio is somewhat more complex. Given that the momentum strategy is the return differential between the winners and the losers, factors such as the stock market cycle or the evolution of momentum portfolios against their reference point make momentum profits difficult to forecast.

Is the Distance to Default a good measure in predicting bank failures? A case study of Japanese major banks

This paper examines the movements of the Distance to Default (DD), a market-based measure of corporate default risk, of major failed Japanese banks in order to evaluate the predictive power of the DD measure for bank failures. The DD became smaller in anticipation of failure for most cases. Both the DD and DD spread, defined as the DD of a failed bank minus the DD of sound banks, were better indicators for deterioration of a failed bank's health than other traditional indicators. A probit model yielded that the quality of the DD was surely better than other measures. For a bank which window-dressed its financial statements, neither the DD nor the DD spread predicted the failure. However, the result was partly due to lack of transparency in financial statements and disclosed information.

我国上市公司信用违约风险的实证检验

上市公司信用违约风险度量的技术在西方已经比较成熟，信用风险度量的方法和模型在理论上和实践中都形成了一套完整的体系。而我国的信用违约风险度量还刚刚起步，对于信用评级还处于探索阶段，远不能达到商业银行对于贷款安全管理的要求。而本文所讨论的KMV模型作为现代四大信用风险度量模型之一，相较于其他三种方法，所需要的参数在中国目前的数据库建设下相对可以获得，其计算方法也有强大的理论依据做支撑，通过计算得到的数值相比传统的信用风险度量方法有更强的说服力，更有利于银行管控风险和上市公司进行诚信建设，促进金融市场发展。结论表明，我国上市公司存在信用违约的风险与模型的实际检验基本一致。因此通过研究信用违约风险度量模型，结合我国金融市场的现状，探索出适合我国信用违约风险度量的模型具有理论和现实意义。 The credit default risk measurement technology of listed Corporation is so mature in the west that a complete system of methods and models of credit risk measurement are formed in theory and practice. But in China, the measurement of credit default risk is still in its infancy and the credit rating is still in the exploratory stage, which can’t meet the needs of commercial bank loans for safety management requirements. As one of modern four major credit risk measurement models, KMV parameters can be obtained in the Chinese current database which is under construction now, and its calculation methods have strong theoretical bases to support itself. The calculated data is more convincing than that from the traditional credit risk measurement methods, which can help the banks to control the risks and the listed corporations to build its integrity, promoting the financial market. The results show that credit default risk of listed Chinese companies is almost consentaneous to this empirical test of models. Thus, through the research of credit default risk measurement models, exploring the Chinese credit default model has significance both in theory and practice.

Logistic Predictive Model for SMEs Financing in India

Credit assessment risk for small and medium enterprises (SMEs) offers special challenges to practitioners, regulators and academics. The lenders’ design of the package of credit to SMEs may affect the propensity to default or lead to delinquency. Considering the fundamental role being played by small-sized industries in Indian economy and emphasis on inclusive economy, we aim to develop a default prediction model, specifically for SMEs. Apart from the conventional ‘ability to pay’ basis of analyzing borrower-centric default risk, there may be a set of other explanatory variables that can be modelled to assess the credit default. The study here examines the behaviour of relevant measures of default risk and explores the most significant variables of the financial package to construct a model for SMEs by applying multinomial logistic regression technique. The study is based on database covering two years of the time period from 2007 to 2009 on 2,864 SMEs pertaining to an emerging cluster obtained from a prominent financial institution in Delhi.

State Antipredatory Lending Laws and Neighborhood Foreclosure Rates

ABSTRACT:In this study, we examine the impact of state antipredatory lending laws (APLs) on neighborhood foreclosure and delinquency rates using a set of panel data regression models. We find strong evidence that neighborhoods have lower default rates in states with laws that extended federal coverage and/or restricted more mortgage contract terms, in states with broader coverage of subprime loans with high points and fees, and in states with more restrictive regulations on prepayment penalties. A typical APL lowers neighborhood default rates by between 3.8% and 18%, depending on the default risk measure considered. The findings remain consistent when we restrict the analysis to cross-border neighborhoods, suggesting that they are not due solely to unobservable market variation.

Term Structure of Credit Default Swap Spreads and Cross-Section of Stock Returns

The slope of a firm's term structure of credit default swap (CDS) spreads (five-year spread minus one-year spread) negatively predicts future stock returns. Stocks with low CDS slope on average outperform stocks with high CDS slope by over 1% each month for the next six months. Our result can not be explained by standard risk factors, stock characteristics, default risk measures or changes in CDS spreads. We find that CDS slope positively predicts future changes in CDS spreads, but the information content of CDS slope only slowly gets incorporated into stock price. CDS slope predicts return mainly for stocks facing high arbitrage costs.

The information content of analysts reports and bankruptcy risk measures

We evaluate the information content of analysts’ reports and bankruptcy risk quantities towards each other, and examine whether differences arise between low- and high-risk firms and between stock recommendations and earnings forecasts. We reveal that past changes in analysts’ reports convey valuable information towards future developments in default risk measures, analysts’ outcome rely upon lagged modifications in corporate creditworthiness, and the predictive power in both directions is more pronounced among high risk enterprises. Furthermore, default likelihoods and analysts’ recommendations and forecasts Granger cause each other, generating a significant feedback system. Moreover, earnings forecasts portray more profound relations to credit risk quantities than stock recommendations.

Market discipline of banks: Why are yield spreads on bank-issued subordinated notes and debentures not sensitive to bank risks?

The default risk sensitivity of yield spreads on bank-issued subordinated notes and debentures (SNDs) decreased after banks started issuing trust-preferred securities (TPS). The too-big-to-fail (TBTF) discount on yield spreads is absent prior to the LTCM bailout, but the size discount doubles after the LTCM bailout. Prior to TPS issuance and the LTCM bailout, SND yield spreads are sensitive to conventional firm-specific default risk measures, but not after the bailout. We find paradigm shift in determinants of yield spreads after the LTCM bailout. Yield spreads on TPS are sensitive to default risks and can provide an additional source of market discipline.

An analysis of credit risk spreads for high yield bonds

The overall growth and volatility in the high yield (HY) bond market has provided a viable source of capital and an interesting investment asset class. The result has been strong interest in the HY bond credit risk spread (CRS) because this series is very volatile and has a significant impact on the availability of capital to issuers and the rates of return and risk results for investors. Given these trends in the HY bond market, our study has two purposes. The first is to examine statistical properties of the CRS series for the aggregate HY bond market and the three rated components. The second purpose is to interpret the influence that a set of variables are expected to have on future CRSs and, therefore, HY bond performance. In summary, the statistical analysis indicates a significant business cycle effect, but does not show a monetary policy impact. Additionally, the study finds significant differences in characteristics among bonds with alternative ratings. The analysis of specific variables highlights the strong influence of direct and indirect measures of default risk, capital market risk factors, a specific measure of monetary policy, and an impact from liquidity within the HY bond market. There was also evidence of segmentation within the HY bond market because the empirical results indicate that we should consider separate models across rating classes that employed different variables as well as coefficients that were significantly different for the same variables.

Pricing model of interest rate swap with a bilateral default risk

Under the foundation of Duffie & Huang (1996) [7], this paper integrates the reduced form model and the structure model for a default risk measure, giving rise to a new pricing model of interest rate swap with a bilateral default risk. This model avoids the shortcomings of ignoring the dynamic movements of the firm’s assets of the reduced form model but adds only a little complexity and simplifies the pricing formula significantly when compared with Li (1998) [10]. With the help of the Crank–Nicholson difference method, we give the numerical solutions of the new model to study the default risk effects on the swap rate. We find that for a one year interest rate swap with the coupon paid per quarter, the variance of the default fixed rate payer decreases from 0.1 to 0.01 only causing about a 1.35%’s increase in the swap rate. This is consistent with previous results.

Mind the Gap: Disentangling Credit and Liquidity in Risk Spreads

Wide and volatile interest rate spreads in the 2007-2009 financial crisis could represent concerns over asset liquidity or issuer solvency. To precisely identify the contribution of these two effects on sovereign bond and interbank spreads, I propose a model-free measure of euro-area market liquidity, and a measure of near-term interbank default risk. I find that credit and liquidity are independently important. In interbank risk spreads, the role of liquidity dominates, while the importance in sovereign bond yield spreads varies substantially by country and maturity. To better understand the liquidity channel that is captured by the new liquidity measure, but is understated by extant measures, I test the pricing of liquidity risk; the possibility that liquidity could be negatively correlated with marginal utility. I exploit the variation in returns over countries, maturities and time, and find that liquidity euro-area sovereign bond risk premia are large and significant.

Do Mergers Improve Information? Evidence from the Loan Market

We examine the informational effects of M&As by investigating whether bank mergers improve banks' ability to screen borrowers. By exploiting a data set in which we observe a measure of a borrower's default risk that the lenders observe only imperfectly, we find evidence of these informational improvements. Mergers lead to a closer correspondence between interest rates and individual default risk: after a merger, risky borrowers experience an increase in the interest rate, while nonrisky borrowers enjoy lower interest rates. These informational benefits appear to derive from improvements in information processing resulting from the merger, rather than from explicit information sharing on individual customers among the merging parties. Our evidence suggests that part of these informational improvements stem from the consolidated banks using “hard” information more intensively.

The Determinants of Yield Spreads and the Market Discipline of Banks

Determinants of yield spreads vary with market conditions and available information, which has implications for debt pricing models. After the bailout of Long Term Capital Management (LTCM) in September 1998, important firm-specific default risk measures, such as leverage, are not significant factors in determining yield spread levels of bank-issued subordinated notes and debentures (SND) because these measures do not reflect the true risk of the firm. Bond markets impound a higher cost for higher risk-taking, particularly for off-balance sheet risks, based on return-on-assets, after the LTCM bailout, Yield spreads have become less sensitive to firm-specific risks, even prior to the LTCM bailout, after the issuance of trust-preferred securities (TPS) by banks because TPS are junior claims to SND and provide an additional buffer to SND from default risk. Yield spreads on SND prior to TPS issuance by banks and the LTCM bailout are sensitive to conventional firm-specific risk measures. Yield spreads on TPS at the time of offer provide market signals about on-balance sheet risks.

A Volatility Smirk that Defaults: The Case of the S&P 500 Index Options

This paper examines the time series economic determinants of Standard & Poor’s (S&P) 500 Index option-implied risk-neutral distributions for the period 1998–2007. In particular, we investigate the effects of a market default likelihood index, which is computed by aggregating daily default risk measures for all individual, non-financial firms included in the S&P 500 Index portfolio. The results reveal that market default risk is positively (negatively) related to the index risk-neutral volatility and skewness (kurtosis). Moreover, the findings of this study illuminate a set of economic determinants relating to the characteristics of the underlying asset and microstructure variables characterizing the option market, which are also found to affect the index option-implied risk-neutral moments. Overall, our findings provide a better understanding of what drives the daily shapes of the S&P 500 option-implied risk-neutral distributions and offer explanations of why theoretical predictions of rational option pricing models are not consistent with what is observed in practice.

Modeling Simultaneous Defaults

This article provides a new approach to modeling dependent defaults in a portfolio. Our top-down approach involves modeling the defaults of a set of firms and then allocating the aggregate default risk in each set to the individual firms in the set. The major advantage of our approach is that we can easily incorporate economic factors that lead to high correlations in default intensities. Once we obtain a measure of default risk for a set of firms we apply a process called random thinning to characterize the default intensity of a single firm that is a member of the set. Each firm is assigned a portion of its set9s default risk based on firm characteristics such as leverage, asset volatility, and asset correlation. This allows both pricing of portfolios and single name credits with the ease of a reduced form model and the economic motivation of a structural model. Furthermore, we do comparative static exercises to show how the model behaves and we conduct simulations to compare it to the reduced form and structural models9 predictions of single and multi-name credit derivative prices. <b>TOPICS:</b>Accounting and ratio analysis, credit default swaps, simulations

Accounting-Based Versus Market-Based Cross-Sectional Models of CDS Spreads

The relevance of accounting data to providers of capital has been strongly debated. In this paper we provide compelling evidence that accounting metrics are important to providers of debt capital. Models of firm distress are mostly either purely accounting-based (e.g. Altman, 1968; Ohlson, 1980) or purely market-based (e.g. Merton, 1974). We examine the information content of accounting-based and market-based metrics in pricing firm distress using a sample of Credit Default Swap (CDS) spreads. Credit Default Swaps are derivatives that offer protection from the event a given firm defaults on its obligations. CDS spreads provide a clean measure of default risk as they are the compensation that market participants require for bearing that risk. Using a sample of 2,860 quarterly CDS spreads available over the period 2001-2005 we find that a model of distress which is entirely composed of accounting-based metrics performs comparably, if not better, than market-based structural models of default. Furthermore, we find that both sources of information (accounting- and market-based) are complementary in pricing distress. These results support the notion that accounting metrics have direct value- or valuation-relevance to debt holders and holders of credit derivatives.

Distance-to-default in banking: A bridge too far?

In contrast to corporate defaults, regulators typically take a number of statutory actions to avoid the large fiscal costs associated with bank defaults. The distance-to-default, a widely used market-based measure of corporate default risk, overlooks such regulatory actions. To overcome this limitation, this paper introduces the concept of distance-to-capital that accounts for pre-default regulatory actions such as those prescribed in a prompt-corrective-actions framework. We show that both risk measures can be analysed using the same theoretical framework but differ depending on the level of capital adequacy thresholds and asset volatility. We also use the framework to illustrate pre-default regulatory actions in Japan in 2001–2003.

ON THE RAND: DETERMINANTS OF THE SOUTH AFRICAN EXCHANGE RATE

AbstractThis paper is an econometric investigation of the determinants of the real value of the South African rand over the period 1984‐2007. The results show a relatively good fit. As always with exchange rate equations, there is substantial weight on the lagged exchange rate, which can be attributed to a momentum component. Nevertheless, economic fundamentals are significant and important. This is especially true of an index of the real prices of South African mineral commodities, which even drives out real income as a significant determinant. An implication is that the 2003‐2006 real appreciation of the rand can be attributed to the Dutch Disease. In other respects, the rand behaves like currencies of industrialised countries with well‐developed financial markets. In particular, high South African interest rates raise international demand for the rand and lead to real appreciation, controlling also for a forward‐looking measure of expected inflation and a measure of default risk or country risk.

Ratings Versus Market-Based Measures of Default Risk of East Asian Banks

This paper assesses whether agency ratings and market-based default risk measures are consistent for East Asian banks during the period from 1996 to 2006. While the market-based measures are broadly consistent with the credit rating assessments for the banks in the developed economies, the discrepancy between ratings and the market-based measures for the East Asian banks are significant. The credit ratings had been adjusted slowly for the East Asian banks during the onset of the Asian financial crisis. The relatively higher default risk implied by ratings during the post-crisis period is partly due to the conservatism of rating agencies and the unsolicited ratings. The discrepancy still exists after taking these two factors into account. From a prospective of the banking policies, the use of agency-based or market-based measures for calculating capital requirements of exposures to banks and deposit insurance premiums in the East Asian economies could raise an issue of systematic differences between the two measures.

The Complementary Nature of Ratings and Market-Based Measures of Default Risk

Agency ratings and market-based measures of default risk are useful complements. Combining the two improves the prediction of defaults over the use of a single measure. While in-sample analysis suggests that one should give more weight to ratings as the horizon increases, or issuers become less risky, a simple equal-weight combination of ratings and market-based measures is hard to beat out of sample. The results suggest that both ratings and market-based measures provide genuine information of their own.