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Estimating Default Probabilities Using Stock Prices: The Swedish Banking Sector During the 1990s Banking Crisis

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  • Hans Byström

Abstract

The growing interest in management of credit risk and estimation of default probabilities has given rise to a range of more or less elaborate credit risk models. Hall and Miles (1990) suggests an approach of estimating failure probabilities based solely on stock market prices. The approach has the advantage of simplicity but relies on market efficiency to hold. In this paper we suggest an extension to the Hall and Miles (1990) model using extreme value theory and apply the extended model to the Swedish financial sector and to individual Swedish banks. The 15 year long sample in our study covers the period of the Swedish banking crisis of the early 1990s. We find a close correspondence between changes in the estimated probabilities of failure and the actual credit events occuring. Credit ratings from major credit rating agencies, on the other hand, are shown to react much less and much slower to credit quality changes.

Suggested Citation

  • Hans Byström, 2003. "Estimating Default Probabilities Using Stock Prices: The Swedish Banking Sector During the 1990s Banking Crisis," Research Paper Series 92, Quantitative Finance Research Centre, University of Technology, Sydney.
  • Handle: RePEc:uts:rpaper:92
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    File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp92.pdf
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    References listed on IDEAS

    as
    1. Brian H. Boyer & Michael S. Gibson & Mico Loretan, 1997. "Pitfalls in tests for changes in correlations," International Finance Discussion Papers 597, Board of Governors of the Federal Reserve System (U.S.).
    2. McNeil, Alexander J. & Frey, Rudiger, 2000. "Estimation of tail-related risk measures for heteroscedastic financial time series: an extreme value approach," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 271-300, November.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    Cited by:

    1. William R. Cline, 2010. "Financial Globalization, Economic Growth, and the Crisis of 2007-09," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 499.

    More about this item

    Keywords

    banking crisis; default; credit risk; extreme value theory;

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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