Predicting and Pricing the Probability of Default
نویسنده
چکیده
In this paper we study how corporate bond defaults can be predicted using financial ratios and how the forecasted probability of default relates to the cross-section of expected stock returns. Using several performance measures we find that the duration model outperforms existing models in correctly classifying both Default and Non-Default firms. Using the default probabilities predicted by our model, we analyze the relation between default risk and the Fama-French distress factors, HML and SMB. We find evidence that supports the interpretation on HML as a distress related factor. Both portfolio and individual stock factor loadings are related to the estimated default probabilities. We find a negative and significant contemporaneous correlation between HML and shocks to the level of aggregate financial distress. JEL classification: C41, G10, G33
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