Economy-Wide Bond Default Rates: A Maximum Expected Utility Approach
Posted: 11 Jan 2006 Last revised: 14 Nov 2011
Date Written: December 14, 2010
Abstract
We consider the 12-month moving average aggregate default rate of S&P-rated US-bonds. We estimate the conditional probability distribution of this default rate as a function of a weighted average bond rating, a lagged default rate and a preliminary predictor that is based on lagged new issuance. Our modeling approach is asymptotically optimal for an expected utility maximizing investor. The resulting conditional probability density is consistent with our intuition. We measure the model's performance by the out-of-sample expected utility. According to this measure, our model clearly outperforms a simple regression model and a Poisson model.
Keywords: maximum expected utility, bond default rates, entropy
JEL Classification: E37
Suggested Citation: Suggested Citation