Article1999

Estimating the Price of Default Risk

724 citations0/0 files storedReview of Financial Studies

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Credit Risk and Financial Regulations Stochastic processes and financial applications Financial Distress and Bankruptcy Prediction

Abstract

A firm's instantaneous probability of default is modeled as a translated square-root diffusion process modified to allow the process to be correlated with default-free interest rates. The parameters of the process are estimated for 161 firms. An extended Kalman filter approach is used that incorporates both the time-series and cross-sectional (term structure) properties of the individual firms' bond prices. The model is reasonably successful at fitting corporate bond yields, while key features of the term structures of yield spreads are captured in the signs and magnitudes of the resulting parameter estimates.

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References

1974ON THE PRICING OF CORPORATE DEBT: THE RISK STRUCTURE OF INTEREST RATES*1993Dynamic Asset Pricing Theory.1974On the Pricing of Corporate Debt: The Risk Structure of Interest Rates 1999Modeling Term Structures of Defaultable Bonds 1995A Simple Approach to Valuing Risky Fixed and Floating Rate Debt 1995Pricing Derivatives on Financial Securities Subject to Credit Risk 1997A Markov Model for the Term Structure of Credit Risk Spreads 1997An Econometric Model of the Term Structure of Interest-Rate Swap Yields

Cited by

2009The Determinants of Credit Default Swap Premia 2001Counterparty Risk and the Pricing of Defaultable Securities 2008Measuring Abnormal Bond Performance 2004Is Default Event Risk Priced in Corporate Bonds?2004The Flight‐to‐Liquidity Premium in U.S. Treasury Bond Prices 2009The Shape and Term Structure of the Index Option Smirk: Why Multifactor Stochastic Volatility Models Work So Well

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