Predicting and Pricing the Probability of Default

44 Pages Posted: 13 Nov 2005  

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

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

Alessio Saretto (Contact Author)

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

800 Campbell Road
SM 31
Richardson, TX 75080
United States
972-883-5907 (Phone)

HOME PAGE: http://www.utdallas.edu/~axs125732

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