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Debt Market Liquidity and Corporate Default Prediction

Author

Listed:
  • Deming Wu

    (Office of the Comptroller of the Currency, United States Department of the Treasury, 400 7th Street SW, Mail Stop 6E-3, Washington, DC 20219, USA)

  • Suning Zhang

    (Department of Accounting, School of Management, George Mason University, USA)

Abstract

Recent research on the subprime crisis and rollover risk suggests that debt market liquidity is a major factor affecting the risk of default. This implies that firms that rely heavily on short-term debt, such as commercial paper (CP), are at greater risk of default. Debt market illiquidity could reduce the value of the firm and thus impact the firm's leverage, which is a major factor in predicting default. We estimate the effect of debt market conditions on the probability of default with a discrete-time dynamic hazard model that takes into account measurement error in firm leverage. Our results indicate that rollover risk is a significant factor in causing default, but the risk was higher for nonfinancial firms around 2000–2001 and considerably less entering the subprime crisis.

Suggested Citation

  • Deming Wu & Suning Zhang, 2014. "Debt Market Liquidity and Corporate Default Prediction," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 4(04), pages 1-33.
    • Handle: RePEc:wsi:qjfxxx:v:04:y:2014:i:04:n:s2010139215500032
    DOI: 10.1142/S2010139215500032
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    More about this item

    Keywords

    Corporate default prediction; liquidity pricing; market valuation; book value accounting; debt market liquidity; rollover risk; G33; G32; G01; C53;
    All these keywords.

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G01 - Financial Economics - - General - - - Financial Crises
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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