Default Risk in Corporate Yield Spreads

Canada Research Chair in Risk Management Working Paper No. 05-08

36 Pages Posted: 8 Nov 2010

See all articles by Georges Dionne

Georges Dionne

HEC Montreal - Department of Finance

Geneviève Gauthier

HEC Montreal - Department of Decision Sciences; HEC Montreal - Department of Management Sciences

Khemais Hammami

HEC Montreal - Department of Finance

Mathieu Maurice

HEC Montréal

Jean-Guy Simonato

HEC Montréal

Date Written: January 10, 2009

Abstract

An important research question examined in the credit risk literature focuses on the proportion of corporate yield spreads attributed to default risk. This topic is reexamined in the light of the different issues associated with the computation of transition and default probabilities obtained from historical default data. We find that the out of sample estimated default risk proportion in corporate yield spreads is highly sensitive to the ex-ante estimated term structure of default probabilities used as inputs. This proportion can become a large fraction of the yield spread when sensitivity analyses are made with respect to the period over which the probabilities are estimated and the recovery rates. The computation of approximate confidence sets evaluates the statistical precision of the estimated proportions which are also shown to be sensitive to the different filtering procedures required to treat the historical default data base.

Keywords: Corporate yield spread, default risk, estimation period, generator, recovery rate, data filtration, confidence intervals

JEL Classification: G21, G32, G33

Suggested Citation

Dionne, Georges and Gauthier, Genevieve and Hammami, Khemais and Maurice, Mathieu and Simonato, Jean-Guy, Default Risk in Corporate Yield Spreads (January 10, 2009). Canada Research Chair in Risk Management Working Paper No. 05-08. Available at SSRN: https://ssrn.com/abstract=854446 or http://dx.doi.org/10.2139/ssrn.854446

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Genevieve Gauthier

HEC Montreal - Department of Decision Sciences ( email )

3000 Côte-Sainte-Catherine Road
Montreal, QC H2S1L4
Canada

HEC Montreal - Department of Management Sciences ( email )

Montreal, Quebec H3T 2A7
Canada

Khemais Hammami

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Mathieu Maurice

HEC Montréal ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Jean-Guy Simonato

HEC Montréal ( email )

3000, chemin de la Cote-Sainte-Catherine
Service de l'enseignement de la finance
Montreal, Quebec H3T 2A7
Canada
514-340-6807 (Phone)
514-340-5632 (Fax)

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