Investigating the Role of Systematic and Firm-Specific Factors in Default Risk: Lessons from Empirically Evaluating Credit Risk Models
This paper proposes and empirically investigates a family of credit risk models driven by a two-factor structure for the short interest rate and an additional factor for firm-specific distress. The firm-specific distress factors include leverage, book-to-market, profitability, equity-volatility, and distance-to-default. Our estimation approach and performance yardsticks show that interest rate risk is of first-order importance for explaining variations in single-name defaultable bond yields. When applied to low-grade bonds, a credit risk model that takes leverage into consideration reduces absolute yield mispricing by as much as 30%. A strategy relying on Treasury instruments is effective in dynamically hedging credit exposures.
Year of publication: |
2006
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Authors: | Bakshi, Gurdip ; Madan, Dilip ; Zhang, Frank Xiaoling |
Published in: |
The Journal of Business. - University of Chicago Press. - Vol. 79.2006, 4, p. 1955-1988
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Publisher: |
University of Chicago Press |
Saved in:
Saved in favorites
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