Predicting and Pricing the Probability of Default

Saretto, Alessio

doi:10.2139/ssrn.556226

Predicting and Pricing the Probability of Default

AFA 2006 Boston Meetings Paper

44 Pages Posted: 13 Nov 2005

See all articles by Alessio Saretto

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: March 10, 2005

Abstract

In this paper we study how corporate bond defaults can be predicted using financial ratios and how the estimated default probability relates to the Fama-French factors, HML and SMB. We propose a default forecast model that outperforms existing models in correctly classifying both Default and Non-Default firms. Using the default probabilities generated by our model, we find evidences that support the interpretation of HML as a distress factor. Factor loadings are positively related to the firm default probabilities. HML is negatively correlated with changes in the level of aggregate financial distress.

Keywords: Default, Hazard Rate, Distress Risk

Suggested Citation: Suggested Citation

Saretto, Alessio, Predicting and Pricing the Probability of Default (March 10, 2005). AFA 2006 Boston Meetings Paper; EFA 2004 Maastricht Meetings Paper No. 4510. Available at SSRN: https://ssrn.com/abstract=556226 or http://dx.doi.org/10.2139/ssrn.556226