A Forward-Looking Measure of Credit Risk
22 Pages Posted: 17 Jul 2019 Last revised: 27 Jun 2023
Date Written: June 27, 2023
In this article, we demonstrate that the asset model incorporating the cumulative effect of negative shocks through a shot noise process detects deteriorated credit quality earlier than the benchmark Merton-type model. We provide mathematical proofs which illustrate the mechanism behind this forward-looking feature. The asset model with a shot noise is a computationally simple extension of the benchmark model. We use the CDS market to exemplify how this model detects high credit risk in a forward-looking manner.
Keywords: asset process, shot noise, distance-to-default, structural model, credit risk, CDS spread
JEL Classification: G01, G17, G32
Suggested Citation: Suggested Citation