Assessing Default Risks for Chinese Firms: A Lost Cause?

33 Pages Posted: 21 Jul 2015

See all articles by Daniel Law

Daniel Law

International Monetary Fund (IMF)

Shaun K. Roache

International Monetary Fund (IMF)

Date Written: June 2015

Abstract

Assessing default risks for Chinese firms is hard. Standard measures of risk using market indicators may be unreliable because of implicit guarantees, the large role played by less-informed investors, and other market imperfections. We test this assertion by estimating stand-alone 1-year default probabilities for non-financial firms in China using an equity-based structural model and debt costs. We find evidence that the equity measure of default risk is sensitive to a firm’s balance sheet health, profitability, and ownership; specifically, default probabilities are higher for weaker, less profitable, and state-owned firms. In contrast, measures based on the cost of debt seem largely detached from fundamentals and instead determined by implicit guarantees. We conclude that for individual firms, equity-based measures, while far from perfect, provide a better measure of stand-alone default risks than borrowing costs.

Keywords: Default, China, Corporate sector, Public non-financial corporations, Credit risk, default probabilities, equity, market, debt, borrowing costs, markets, liabilities, guarantees, implicit guarantees, investors

JEL Classification: G12, G13, G17, G33

Suggested Citation

Law, Daniel and Roache, Shaun K., Assessing Default Risks for Chinese Firms: A Lost Cause? (June 2015). IMF Working Paper No. 15/140, Available at SSRN: https://ssrn.com/abstract=2633926

Daniel Law (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Shaun K. Roache

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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