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Assessing Credit Risk of Companies with Mean-Reverting Leverage Ratios

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Author Info
C. F. Lo (The Chinese University of Hong Kong, Hong Kong Institute for Monetary Research)
T. C. Wong (Hong Kong Monetary Authority)
C. H. Hui (Hong Kong Monetary Authority)
M. X. Huang (University of Technology, Sydney)
Abstract

Empirical findings and theoretical studies suggest that firms adjust towards time-varying target leverage ratios. This paper studies the performances of the default probabilities generated from two stationaryleverage models with time-dependent and constant target ratios respectively. The time-dependent model consistently performs better in terms of discriminatory power of differentiating firms' default risk and capability for predicting default rates over the period 1996 to 2006. The model provides appropriate measures of credit risk of firms and evidence to support the existence of a time-varying target leverage ratio.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 042008.

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Length: 31 pages
Date of creation: Apr 2008
Date of revision:
Handle: RePEc:hkm:wpaper:042008

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Related research
Keywords: Leverage; Default probabilities; Credit risk;

Find related papers by JEL classification:
C60 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - General
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
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  8. Marsh, Paul, 1982. " The Choice between Equity and Debt: An Empirical Study," Journal of Finance, American Finance Association, vol. 37(1), pages 121-44, March. [Downloadable!] (restricted)
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  1. Gunter Löffler & Alina Maurer, 2009. "Incorporating the Dynamics of Leverage into Default Prediction," SFB 649 Discussion Papers SFB649DP2009-024, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
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