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Are Corporates' Target Leverage Ratios Time-Dependent?

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  • Cho-hoi Hui

    (Research Department, Hong Kong Monetary Authority)

Abstract

This paper extends the stationary-leverage-ratio model of credit risk measurement to incorporate a time-dependent target leverage ratio of a firm. The theoretical hypothesis of the existence of a time-dependent target leverage ratio reflects the movement of a firm's initial target ratio toward a long-term target ratio over time. Using some simple scenarios about the time-dependence of the target leverage ratio, the numerical results show that the incorporation of the hypothesis into the stationary leverage- ratio model is capable of producing term structures of probabilities of default that are consistent with some empirical findings reported by Standard and Poor's. The results provide some evidences to support the hypothesis. The results of the predictions of probabilities of default also support that the time dependent model can be used for credit risk measurement of corporate exposures for the New Basel Capital Adequacy Standards purposes.

Suggested Citation

  • Cho-hoi Hui, 2005. "Are Corporates' Target Leverage Ratios Time-Dependent?," Working Papers 0503, Hong Kong Monetary Authority.
    • Handle: RePEc:hkg:wpaper:0503
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