A Simple Continuous Measure of Credit Risk
This 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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|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.|
|Contact details of provider:|| Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden|
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Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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