Private Firm Default Probabilities Via Statistical Learning Theory and Utility Maximization

We estimate real-world private firm default probabilities over a fixed time horizon,conditioned on a vector of explanatory variables, which include financial ratios, economic indicators, and market prices. To estimate our model, we apply a recently developed method from statistical learning theory. This method leads to a model that is particularly appropriate for financial market participants who would use the model to make financial decisions. We compare our model with various benchmark models, with respect to a number of performance measures. In all of these tests, our model outperformed the benchmark models. We also discuss possible reasons for this outperformance.A revised version of this paper appeared in the Journal of Credit Risk, Volume 2/Number 1, Spring 2006