Distance-to-Default and Credit Spread of Corporate Bonds
Date Issued
2006
Date
2006
Author(s)
Chang, Hui-Ju
DOI
en-US
Abstract
Since the classic study of credit risk valuation was pioneered by Merton (1974), assessing the reasonable credit spread of corporate bonds has become one important issue related to the bond market research. In practice, the credit rating has been the key factor in determining the credit spread of a firm’s debt. However, the credit rating is revised infrequently and quite often with a lag. It may not reflect the true default risks of bonds efficiently. So in recent years, the distance-to-default (DD) inspired by Moody's KMV Expected Default FrequencyTM (EDFTM) credit measure becomes another evaluation criterion to assess the credit quality and to determine the credit spread.
Generally, the greater the DD, the lower the credit risk, the higher the credit rating, and thus the lower the credit spread. Using 1,738 US corporate bonds issued by 479 firms, we document the empirical success of DD in explaining credit spreads. Besides, we compare the power of DD with that of credit ratings to explain credit spreads. The results show that the performance of DD in explaining credit spreads is in no way inferior to that of credit ratings. DD captures some information that is not contained in credit ratings. In addition, the credit rating must be supplied by major rating agencies whereas DD only requires the equity prices and certain items from financial statements as input, so it is more responsive to the everchanging financial status of the issuer, and can be calculated as frequently as the users like. DD may be able to replace the credit rating to a certain extent. On the verge of the implementation of Basel II Accord, these findings may provide a useful risk control concept for financial institutions, underwriters, investors, issuers, and the regulators.
Subjects
公司債
信用貼水
違約距離
信用評等
預期違約頻率衡量模型
Corporate bonds
credit spread
distance-to-default
credit rating
Expected Default FrequencyTM credit measure
Type
thesis
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