Probability of default and/or bankruptcy
Posted: November 17th, 2008, 11:28 pm
by tttchen
I'm sure this exists somewhere--I'm looking for something that addresses the probability of bankruptcy and/or default based on credit ratings on debt. For example, what is the likelihood of bankruptcy for a company with BB-rated debt? Thanks for your help!
Probability of default and/or bankruptcy
Posted: November 28th, 2008, 12:59 am
by rajeck
As default probabilities have many factors than the bond rating, there isn't a one-to-one mapping, but Moody's does publish data like "Average Cumulative Credit Loss Rates by Whole Letter Rating, 1982-2004" (just google that to find the doc). Those averages, however, may not be useful in this current economic climate so it may be worthwhile to calculate the default probability that's implied by the current spread between the defaultable bond and a risk-free bond. One simple formula for that is:(t,T): time t to time T - so (0,4) is from now till year 4P(t,T), Pd(t,T): The price of default-free and defaultable ZCB, respectively (pricing the ZCB using the yield)R: Recovery rate of bond after defaultDefault Probability(t,T)=(Pd(t,T)-P(t,T)) / ((1-R)*P(t,T))Of course, the resulting probability is subject to nebulous input data such as the recovery rate (which is, of course, unknowable before default) and a suitable risk-free bond, but at least it's a start!