Expected Default Probability, Credit Spreads and Distance-from-Default
Journal of American Academy of Business, Vol. 7, No. 1, pp. 144-152, 2005
9 Pages Posted: 16 Dec 2005
This article analyzes the information content of the distance-from-default regarding a firm's default risk. Under the Merton's (1974) option pricing model, both the relation between the expected default probability of a firm and its distance-from-default, and the relation between the credit spreads and distance-from-default are examined. We demonstrate that both expected default probability and credit spreads could be expressed by the analytical function of the distance-from-default. This means that people can easily infer a firm's expected default probability and also its credit spreads from the information of the value of a firm's distance-from-default.
Keywords: distance-from-default, expected default probability, credit spreads, default risk modeling
JEL Classification: G13, G33
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