Confidence Intervals for Corporate Default Rates

14 Pages Posted: 22 Jun 2007

See all articles by Richard Cantor

Richard Cantor

Moody's Investors Service

David T. Hamilton

Moody's Analytics

Jennifer Tennant

Moody's Investors Service

Multiple version iconThere are 2 versions of this paper

Date Written: April 2007

Abstract

Rating agency default studies provide estimates of mean default rates over multiple time horizons but have never included estimates of the standard errors of the estimates. This is due at least in part to the challenge of accounting for the high degree of correlation induced by their cohort-based methodologies. In this paper, we present a method for estimating confidence intervals for corporate default rates derived through a bootstrapping approach. The work extends research in the academic literature on one-year default rates [Hanson and Schuermann (2006)] to the multi-year horizon case. Our results indicate that historical mean speculative-grade default rates are generally measured fairly precisely, with standard errors less the 10% of the estimated means. Investment-grade default rates, however, are measured much less precisely, particularly for issuers rated single A or above. Precision increases at longer horizons. Of practical importance, the results indicate that Moody's long-term ratings satisfy the Basel II criteria for effectively distinguishing relative credit risk. This is true even for "low-default portfolio" portion of the rating scale - letter ratings Aaa, Aa, and single A - because the default rates associated with these rating categories are significantly different from one another at the two-year and longer investment horizons.

Keywords: default probability, bootstrap, risk management

JEL Classification: C14, G21, G28

Suggested Citation

Cantor, Richard Martin and Hamilton, David T. and Tennant, Jennifer, Confidence Intervals for Corporate Default Rates (April 2007). Available at SSRN: https://ssrn.com/abstract=995545 or http://dx.doi.org/10.2139/ssrn.995545

Richard Martin Cantor

Moody's Investors Service ( email )

99 Church Street
New York, NY 10007
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David T. Hamilton (Contact Author)

Moody's Analytics ( email )

7 World Trade Center
250 Greenwich Street
New York, NY 10007
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(212) 553-1695 (Phone)

HOME PAGE: http://web.mac.com/dthamilton

Jennifer Tennant

Moody's Investors Service ( email )

99 Church Street
New York, NY 10007
United States
212-553-4159 (Phone)

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