A Simple Continuous Measure of Credit Risk
AbstractThis paper introduces a simple continuous measure of credit risk that associates to each firm a risk parameter related to the firm's risk-neutral default intensity. These parameters can be computed from quoted bond prices and allow assignment of credit ratings much finer than those provided by various rating agencies. We estimate the risk measures on a daily basis for a sample of US firms and compare them with the corresponding ratings provided by Moody's and the distance to default measures calculated using the Merton (1974) model. The three measures group the sample of firms into various risk classes in a similar but far from identical way, possibly reflecting the models' different forecasting horizons. Among the three measures, the highest rank correlation is found between our continuous measure and Moody's ratings. The techniques in this paper can be used to extract the entire distribution of inter-temporal risk-neutral default intensities which is useful for time-to-default estimations as well as for pricing credit derivatives.
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Bibliographic InfoPaper provided by Lund University, Department of Economics in its series Working Papers with number 2003:14.
Length: 18 pages
Date of creation: 24 Oct 2003
Date of revision: 18 Jan 2005
Publication status: Published in International Review of Financial Analysis, 2007, pages 508-523.
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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
More information through EDIRC
credit risk; credit rating; corporate bonds;
Other versions of this item:
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-11-09 (All new papers)
- NEP-CFN-2003-11-09 (Corporate Finance)
- NEP-FIN-2003-11-09 (Finance)
- NEP-FMK-2003-11-09 (Financial Markets)
- NEP-RMG-2003-11-09 (Risk Management)
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