Predicting and Pricing the Probability of Default
44 Pages Posted: 13 Nov 2005
Date Written: March 10, 2005
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
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