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183
Forecasting Default with the Merton Distance to Default Model
- Review of Financial Studies
, 2008
"... We examine the accuracy and contribution of the Merton distance to default (DD) model, which is based on Merton’s (1974) bond pricing model. We compare the model to a “naı̈ve” alternative, which uses the functional form suggested by the Merton model but does not solve the model for an implied probab ..."
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Cited by 168 (4 self)
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We examine the accuracy and contribution of the Merton distance to default (DD) model, which is based on Merton’s (1974) bond pricing model. We compare the model to a “naı̈ve” alternative, which uses the functional form suggested by the Merton model but does not solve the model for an implied probability of default. We find that the naı̈ve predictor per-forms slightly better in hazard models and in out-of-sample forecasts than both the Merton DD model and a reduced-form model that uses the same inputs. Several other forecasting variables are also important predictors, and fitted values from an expanded hazard model outperform Merton DD default probabilities out of sample. Implied default probabilities from credit default swaps and corporate bond yield spreads are only weakly correlated with Merton DD probabilities after adjusting for agency ratings and bond characteristics. We conclude that while the Merton DD model does not produce a sufficient statistic for the prob-ability of default, its functional form is useful for forecasting defaults. (JEL G12, G13, G33) 1.
Does Investor Misvaluation Drive the Takeover Market?
, 2003
"... This paper tests the hypothesis that irrational market misvaluation a#ects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of residual income model value to price. Misvaluation of bidders and targets ..."
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Cited by 126 (8 self)
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This paper tests the hypothesis that irrational market misvaluation a#ects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of residual income model value to price. Misvaluation of bidders and targets influences the means of payment chosen, the mode of acquisition, the premia paid, target hostility to the o#er, the likelihood of o#er success, and bidder and target announcement period stock returns. The evidence is broadly supportive of the misvaluation hypothesis
Frailty Correlated Default
- Journal of Finance
, 2009
"... Abstract This paper shows that the probability of extreme default losses on portfolios of U.S. corporate debt is much greater than would be estimated under the standard assumption that default correlation arises only from exposure to observable risk factors. At the high confidence levels at which b ..."
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Cited by 70 (4 self)
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Abstract This paper shows that the probability of extreme default losses on portfolios of U.S. corporate debt is much greater than would be estimated under the standard assumption that default correlation arises only from exposure to observable risk factors. At the high confidence levels at which bank loan portfolio and CDO default losses are typically measured for economic-capital and rating purposes, our empirical results indicate that conventionally based estimates are downward biased by a full order of magnitude on test portfolios. Our estimates are based on U.S. public non-financial firms existing between 1979 and 2004. We find strong evidence for the presence of common latent factors, even when controlling for observable factors that provide the most accurate available model of firm-by-firm default probabilities.
In search of distress risk
"... This paper explores the determinants of corporate failure and the pricing of financially distressed stocks whose failure probability, estimated from a dynamic logit model using accounting and market variables, is high. Since 1981, financially distressed stocks have delivered anomalously low returns. ..."
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Cited by 69 (3 self)
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This paper explores the determinants of corporate failure and the pricing of financially distressed stocks whose failure probability, estimated from a dynamic logit model using accounting and market variables, is high. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with low failure risk. These patterns are more pronounced for stocks with possible informational or arbitrage-related frictions. They are inconsistent with the conjecture that value and size e¤ects are compensation for the risk of financial distress.
Credit spreads and business cycle fluctuations.
, 2012
"... Abstract We re-examine the evidence on the relationship between credit spreads and economic activity, by constructing a credit spread index based on an extensive data set of prices of outstanding corporate bonds trading in the secondary market. Compared with the standard default-risk indicators, ou ..."
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Cited by 55 (0 self)
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Abstract We re-examine the evidence on the relationship between credit spreads and economic activity, by constructing a credit spread index based on an extensive data set of prices of outstanding corporate bonds trading in the secondary market. Compared with the standard default-risk indicators, our credit spread index is a robust predictor of economic activity at both the short-and longer-term horizons. Using an empirical framework, we decompose the index into a predictable component that captures the available firm-specific information on expected defaults and a residual component-the excess bond premium-which we argue likely reflects variation in the price of default risk rather than variation in the risk of default. Our results indicate that the predictive content of credit spreads for economic activity is due primarily to movements in the excess bond premium. Innovations in the excess bond premium that are orthogonal to the current state of the economy are shown to lead to significant declines in economic activity and equity prices. We also show that a deterioration in the creditworthiness of broker-dealers-key financial intermediaries in the corporate cash market-causes an increase in the excess bond premium. These findings support the notion that a rise in the excess bond premium represents a reduction in the effective risk-bearing capacity of the financial sector and, as a result, a contraction in the supply of credit with significant adverse consequences for the macroeconomy. JEL Classification: E32, E44, G12
The Eco-Efficiency Premium Puzzle
- Financial Analysts Journal
, 2005
"... Does socially responsible investing (SRI) lead to inferior or superior portfolio performance? This study focused on the concept of “eco-efficiency, ” which can be thought of as the economic value a company creates relative to the waste it generates, and found that SRI produced superior performance. ..."
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Cited by 51 (2 self)
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Does socially responsible investing (SRI) lead to inferior or superior portfolio performance? This study focused on the concept of “eco-efficiency, ” which can be thought of as the economic value a company creates relative to the waste it generates, and found that SRI produced superior performance. Based on Innovest Strategic Value Advisors ’ corporate eco-efficiency scores, the study constructed and evaluated two equity portfolios that differed in eco-efficiency. The high-ranked portfolio provided substantially higher average returns than its low-ranked counterpart over the 1995–2003 period. This performance differential could not be explained by differences in market sensitivity, investment style, or industry-specific factors. Moreover, the results remained significant for all levels of transaction costs, suggesting that the incremental benefits of SRI can be substantial. n recent decades, a large number of investors have embraced the concept of socially respon-sible investing (SRI). Currently, nearly 12 per-cent of assets under management are invested according to ethical criteria (Social Investment Forum 2001). However, despite the increasing pop-
Multi-Period Corporate Failure Prediction with Stochastic Covariates
, 2004
"... We provide maximum likelihood estimators of term structures of conditional probabilities of bankruptcy over relatively long time horizons, incorporating the dynamics of firm-specific and macroeconomic covariates. We find evidence in the U.S. industrial machinery and instruments sector, based on ..."
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Cited by 38 (5 self)
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We provide maximum likelihood estimators of term structures of conditional probabilities of bankruptcy over relatively long time horizons, incorporating the dynamics of firm-specific and macroeconomic covariates. We find evidence in the U.S. industrial machinery and instruments sector, based on over 28,000 firm-quarters of data spanning 1971 to 2001, of significant dependence of the level and shape of the term structure of conditional future bankruptcy probabilities on a firm's distance to default (a volatility-adjusted measure of leverage) and on U.S. personal income growth, among other covariates. Variation in a firm's distance to default has a greater relative e#ect on the term structure of future failure hazard rates than does a comparatively sized change in U.S. personal income growth, especially at dates more than a year into the future.
Default-risk, shareholder advantage, and stock returns, forthcoming, Review of Financial Studies
, 2006
"... ∗We are grateful to Moody’s KMV for providing us with the data on Expected Default Frequency (EDF) and to Jeff Bohn and Shisheng Qu of Moody’s KMV for help with the data and for insightful suggestions. We appreciate useful comments and suggestions from Jonathan Berk, Jason Chen, Sanjiv ..."
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Cited by 36 (4 self)
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∗We are grateful to Moody’s KMV for providing us with the data on Expected Default Frequency (EDF) and to Jeff Bohn and Shisheng Qu of Moody’s KMV for help with the data and for insightful suggestions. We appreciate useful comments and suggestions from Jonathan Berk, Jason Chen, Sanjiv
Levered Returns
, 2007
"... In this paper we revisit the theoretical relation between financial leverage and stock returns in a dynamic world where both the corporate investment and finance decisions are endogenous. We find that the link between leverage and stock returns is more complex than the static textbook examples sugge ..."
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Cited by 35 (7 self)
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In this paper we revisit the theoretical relation between financial leverage and stock returns in a dynamic world where both the corporate investment and finance decisions are endogenous. We find that the link between leverage and stock returns is more complex than the static textbook examples suggest and will usually depend on the investment opportunities available to the firm. In the presence of financial market imperfections leverage and investment are generally correlated so that highly levered firms are also mature firms with relatively more (safe) book assets and fewer (risky) growth opportunities. We use a quantitative version of our model to generate empirical predictions concerning the empirical relationship between leverage and returns. We test these implications in actual data and find support for them.
