Measuring Default Risk from Market Price Multiple Periods Assume that the bond has only one payment of $100 in T periods: P Default: f*100 No Default: 100

Cumulative Default Rate Measuring Default Risk from Market Price Multiple Periods : Survival Rate Cumulative Default Rate Multiplying by (-1) and adding 1:

Measuring Default Risk from Market Price Which can be rewritten as : CDRT is the Cumulative Default Rate at year T.

Measuring Default Risk from Market Price Assuming that the yield also reflects risk premium:

Measuring Default Risk from Market Price Numerical Example IBM 10-year zero coupon bond is rated A. The bond is traded at 7% YTM and Treasury 10-year zero coupon bond traded at 6% YTM. The recovery rate is 45%. What is the cumulative default rate for 10 years? What is the average marginal default rate? The Cumulative Default Rate (CDR) for 10 years is:

Measuring Default Risk from Market Price

Measuring Default Risk from Market Price According to S&P data the 10-year CDR for A rated bond is only 3.5%. The deference induced by the fact that a large part of the credit spread reflects a risk premium. For instance, assume that 0.7% out of the credit spread reflects a risk premium. In this case the 10-year CDR is:

Measuring Default Risk from Equity Prices The credit spread approach is only useful when there is a good bond market data. In practice, there are many countries that do not have a developed bond market. In addition, the firm may do not have publicly traded bond. In this case we can use the firm’s stock price in order to estimate the credit risk parameters