Predicting and Pricing the Probability of Default
University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics
March 10, 2005
AFA 2006 Boston Meetings Paper
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.
Number of Pages in PDF File: 44
Keywords: Default, Hazard Rate, Distress Risk
Date posted: November 13, 2005