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Assessing Credit Risk of Companies with Mean-Reverting Leverage Ratios

Author

Listed:
  • 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.

Suggested Citation

  • C. F. Lo & T. C. Wong & C. H. Hui & M. X. Huang, 2008. "Assessing Credit Risk of Companies with Mean-Reverting Leverage Ratios," Working Papers 042008, Hong Kong Institute for Monetary Research.
    • Handle: RePEc:hkm:wpaper:042008
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    References listed on IDEAS

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    1. repec:hum:wpaper:sfb649dp2009-024 is not listed on IDEAS
    2. Löffler, Gunter & Maurer, Alina, 2009. "Incorporating the dynamics of leverage into default prediction," SFB 649 Discussion Papers 2009-024, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    3. Löffler, Gunter & Maurer, Alina, 2011. "Incorporating the dynamics of leverage into default prediction," Journal of Banking & Finance, Elsevier, vol. 35(12), pages 3351-3361.

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    More about this item

    Keywords

    Leverage; Default probabilities; Credit risk;
    All these keywords.

    JEL classification:

    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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