Information Noise and Credit Risk: Evidence from Corporate Bankruptcy
41 Pages Posted: 31 Oct 2013 Last revised: 4 Jun 2017
Date Written: May 31, 2017
Theory predicts that information noise induces interactions between the degree of noise and credit risk determinants (Duffie and Lando [2001, Econometrica 69 633-664]). Using well-known bankruptcy hazard models and over two million firm-months of data during 1979-2012, we demonstrate the existence of the noise-induced interaction effects, and strong evidence supporting their implications important to empirical credit risk research. The interactions significantly improve out-of-sample forecasting accuracy, with improvements persistent over time, robust to empirical choices, and more substantial when information quality is poorer. Higher degree of noise, while markedly reducing predictability, entails ambiguous changes in credit risk, which might reconcile inconsistent empirical findings in the literature.
Keywords: Credit Risk, Bankruptcy Forecasting, Information Noise, Hazard Models, Survival Analysis, Probability of Default
JEL Classification: C41, G17, G33
Suggested Citation: Suggested Citation