Benchmarking Model of Default Probabilities of Listed Companies

11 Pages Posted: 30 Apr 2007

See all articles by Cho-Hoi Hui

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

T. C. Wong

Hong Kong Monetary Authority - Research Department

Chi-Fai Lo

The Chinese University of Hong Kong

M. X. Huang

Chinese University of Hong Kong - Department of Physics and Institute of Theoretical Physics

Abstract

This paper presents a benchmarking model for validation of default probabilities of listed companies for Basel II purposes. The model is based on the recent studies on the predictive capability of structural credit risk models. Benchmark ratings and one-year default probabilities are assigned to companies by mapping the term structures of default probabilities of the companies generated by a structural model based on stochastic leverage ratios to the term structures of default rates reported by rating agencies. The empirical results show that the benchmarking model has adequate discriminatory power of ranking credit risk. The association between the benchmark ratings and external credit ratings is statistically significant. Benchmark default probabilities obtained from the model could thus be used as alternative external and independent estimates for comparisons with banks' internal default probability estimates. Significant deviations from this benchmark provide a reason to review the internal estimates.

Keywords: Basel II, Default probabilities, Benchmarking models

JEL Classification: C60, G13, G28

Suggested Citation

Hui, Cho-Hoi and Wong, Tak-Chuen and Lo, Chi-Fai and Huang, Ming-Xi, Benchmarking Model of Default Probabilities of Listed Companies. Journal of Fixed Income, Vol. 15, No. 2, pp. 76-86, 2006. Available at SSRN: https://ssrn.com/abstract=982984

Cho-Hoi Hui (Contact Author)

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

Tak-Chuen Wong

Hong Kong Monetary Authority - Research Department ( email )

55/F, Two International Finance Centre,
8 Finance Street, Central,
Hong Kong
Hong Kong

Chi-Fai Lo

The Chinese University of Hong Kong ( email )

Department of Physics
Shatin, N.T., Hong Kong
China

Ming-Xi Huang

Chinese University of Hong Kong - Department of Physics and Institute of Theoretical Physics ( email )

Shatin, N.T.
Hong Kong
Hong Kong

Register to save articles to
your library

Register

Paper statistics

Downloads
376
Abstract Views
1,442
rank
77,206
PlumX Metrics