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An Empirical Estimation of Default Risk of the UK Real Estate Companies

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Author Info
Kanak Patel ()
Prodromos Vlamis ()
Abstract

Based on the Black and Scholes (Black, F., and M. Scholes. (1973). The Pricing of Options and Corporate Liabilities, Journal of Political Economy 81, 637–659) and Merton (Merton, R. C. (1974). On the Pricing of Corporate Debt: The Risk Structure of Interest Rates, Journal of Finance 29, 449–470) (BSM) contingent claims model, and KMV Corporation framework, we estimate the distance to default and the “risk neutral” default probabilities for a sample of 112 real estate companies over the period 1980 to 2001. Our empirical results classifies failed and non-failed companies into Type I error, cases that the BSM-type model fails to predict default when it did occur, and Type II error where BSM-type model predicts default when it did not occur. We find that none of the companies belong to the category of Type I error. Type II error is observed in 12 out of 112 companies. These results support the theoretical underpinnings of the BSM-type structural model in that the two driving forces of default are high leverage and high asset volatility. Copyright Springer Science + Business Media, Inc. 2006

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File URL: http://hdl.handle.net/10.1007/s11146-005-5176-x
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Publisher Info
Article provided by Springer in its journal The Journal of Real Estate Finance and Economics.

Volume (Year): 32 (2006)
Issue (Month): 1 (February)
Pages: 21-40
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Handle: RePEc:kap:jrefec:v:32:y:2006:i:1:p:21-40

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Web page: http://www.springerlink.com/link.asp?id=102945

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Related research
Keywords: credit risk; default probability; real estate companies;

References listed on IDEAS
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  1. Sarig, Oded & Warga, Arthur, 1989. " Some Empirical Estimates of the Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 44(5), pages 1351-60, December. [Downloadable!] (restricted)
  2. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January. [Downloadable!] (restricted)
  3. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November. [Downloadable!] (restricted)
  4. Fons, Jerome S, 1987. " The Default Premium and Corporate Bond Experience," Journal of Finance, American Finance Association, vol. 42(1), pages 81-97, March. [Downloadable!] (restricted)
  5. Jesus Saa-Requejo & Pedro Santa-Clara, 1997. "Bond Pricing with Default Risk," University of California at Los Angeles, Anderson Graduate School of Management 1127, Anderson Graduate School of Management, UCLA. [Downloadable!]
  6. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 12(4), pages 687-720.
  7. Anderson, Ronald & Sundaresan, Suresh, 2000. "A comparative study of structural models of corporate bond yields: An exploratory investigation," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 255-269, January. [Downloadable!] (restricted)
  8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)
  9. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(2), pages 481-523.
  10. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May. [Downloadable!] (restricted)
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  11. Brockman, Paul & Turtle, H. J., 2003. "A barrier option framework for corporate security valuation," Journal of Financial Economics, Elsevier, vol. 67(3), pages 511-529, March. [Downloadable!] (restricted)
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