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Open Access
Article
Publication date: 17 August 2018

Rick van de Ven, Shaunak Dabadghao and Arun Chockalingam

The credit ratings issued by the Big 3 ratings agencies are inaccurate and slow to respond to market changes. This paper aims to develop a rigorous, transparent and robust credit…

1396

Abstract

Purpose

The credit ratings issued by the Big 3 ratings agencies are inaccurate and slow to respond to market changes. This paper aims to develop a rigorous, transparent and robust credit assessment and rating scheme for sovereigns.

Design/methodology/approach

This paper develops a regression-based model using credit default swap (CDS) data, and data on financial and macroeconomic variables to estimate sovereign CDS spreads. Using these spreads, the default probabilities of sovereigns can be estimated. The new ratings scheme is then used in conjunction with these default probabilities to assign credit ratings to sovereigns.

Findings

The developed model accurately estimates CDS spreads (based on RMSE values). Credit ratings issued retrospectively using the new scheme reflect reality better.

Research limitations/implications

This paper reveals that both macroeconomic and financial factors affect both systemic and idiosyncratic risks for sovereigns.

Practical implications

The developed credit assessment and ratings scheme can be used to evaluate the creditworthiness of sovereigns and subsequently assign robust credit ratings.

Social implications

The transparency and rigor of the new scheme will result in better and trustworthy indications of a sovereign’s financial health. Investors and monetary authorities can make better informed decisions. The episodes that occurred during the debt crisis could be avoided.

Originality/value

This paper uses both financial and macroeconomic data to estimate CDS spreads and demonstrates that both financial and macroeconomic factors affect sovereign systemic and idiosyncratic risk. The proposed credit assessment and ratings schemes could supplement or potentially replace the credit ratings issued by the Big 3 ratings agencies.

Details

The Journal of Risk Finance, vol. 19 no. 5
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 1 February 2003

HAYETTE GATFAOUI

An investor in a corporate obligation is exposed to the default risk of the obligor. In this article, the author adapts the dynamic valuation framework to disaggregate systematic…

Abstract

An investor in a corporate obligation is exposed to the default risk of the obligor. In this article, the author adapts the dynamic valuation framework to disaggregate systematic and idiosyncratic default risk of credit instruments. By articulating the distinction between diversifiable and undiversifiable risk, the article develops a two‐factor model for pricing default risk.

Details

The Journal of Risk Finance, vol. 4 no. 3
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 17 September 2018

Jyh-Horng Lin, Xuelian Li and Fu-Wei Huang

This paper aims to theoretically examine the effects of regulatory policyholder protection on spread behavior and default probability of a life insurance company.

Abstract

Purpose

This paper aims to theoretically examine the effects of regulatory policyholder protection on spread behavior and default probability of a life insurance company.

Design/methodology/approach

The authors construct a contingent claim model for the valuation of the equity of a life insurance company. Then, they extend it to model default risk measures associated with a more appropriate behavioral mode of strategic invested asset rate-setting under regulation.

Findings

The findings established that the optimal insurer interest margin is explicitly modeled by a spread between the loan rate and the required guaranteed rate of the company. The effect of the guaranteed rate on the insurer interest margin is positive when the barrier is low, whereas it is negative when the barrier is high. As the barrier increases, the positive effect of the guaranteed rate on the default risk is increased, the negative effect of the participation on the insurer interest margin is decreased and the positive effect of the participation on the default risk is decreased.

Practical implications

Several results derived that should be of interest to investors, analysts, supervising agencies and policymakers. For example, policyholders protected by increasing the guaranteed rate may create a higher risk for the life insurance company to meet its obligations.

Originality/value

The authors’ approach is a significant departure from the existing literature; they differentiate among path-dependent, barrier options and suggest that the life insurance company’s defaults are more commonly triggered by regulatory responses than debt default.

Details

Journal of Modelling in Management, vol. 13 no. 3
Type: Research Article
ISSN: 1746-5664

Keywords

Article
Publication date: 5 February 2021

Mohamad Hassan Shahrour, Isabelle Girerd-Potin and Ollivier Taramasco

The purpose of this study is to examine the relationship between corporate social responsibility (CSR) and the default risk level of firms operating in the Eurozone and how CSR…

Abstract

Purpose

The purpose of this study is to examine the relationship between corporate social responsibility (CSR) and the default risk level of firms operating in the Eurozone and how CSR can provide insurance-like protection during financial/economic downturns.

Design/methodology/approach

Based on prior empirical studies and by integrating the insights of different theories, this study proposes a framework linking CSR, firm default risk and corporate financial performance to explain firms' social behavior that can trigger default risk determinants (e.g. cost of capital, leverage, sales level) directly or indirectly. The authors use a panel regression approach.

Findings

The results support the mitigating effect of CSR on firm default risk. This effect is higher during a financial crisis, suggesting that CSR could provide insurance-like protection during economic downturns. These results hold even after using an alternative risk measure. Granger causality test results strongly suggest that reverse causality is not a concern. An instrumental variable approach is proposed to deal with potential endogeneity issues.

Originality/value

While other studies examine the CSR–firm default risk relationship in US samples, this study focuses on the Eurozone. The novelty of this work is based on its sample and how financial crises are addressed within this relationship. Insurance-like protection concerns both negative announcements and periods (e.g. financial crises, recessions). The study's results are useful for investors and risk managers who intend to manage default risk in their portfolios or firms.

Details

Managerial Finance, vol. 47 no. 7
Type: Research Article
ISSN: 0307-4358

Keywords

Book part
Publication date: 23 November 2015

Anand Goel and Sumon Mazumdar

In fraudulent conveyance cases, plaintiffs allege that by entering into a complex leverage transaction, such as an LBO, a firm’s former owners ensured its subsequent collapse…

Abstract

Purpose

In fraudulent conveyance cases, plaintiffs allege that by entering into a complex leverage transaction, such as an LBO, a firm’s former owners ensured its subsequent collapse. Proving that the transaction rendered the firm insolvent may allow debtors (or their proxies) to claw back transfers made to former shareholders and others as part of the transaction.

Courts have recently questioned the robustness of the solvency evidence traditionally provided in such cases, claiming that traditional expert analyses (e.g., a discounted flow analysis) may suffer from hindsight (and other forms of) bias, and thus not reflect an accurate view of the firm’s insolvency prospects at the time of the challenged transfers. To address the issue, courts have recently suggested that experts should consider market evidence, such as the firm’s stock, bond, or credit default swap prices at the time of the challenged transaction. We review market-evidence-based approaches for determination of solvency in fraudulent conveyance cases.

Methodology/approach

We compare different methods of solvency determination that rely on market data. We discuss the pros and cons of these methods and illustrate the use of credit default swap spreads with a numerical example. Finally, we highlight the limitations of these methods.

Findings

If securities trade in efficient markets in which security prices quickly impound all available information, then such security prices provide an objective assessment of investors’ views of the firm’s future insolvency prospects at the time of challenged transfer, given contemporaneously available information. As we explain, using market data to analyze fraudulent conveyance claims or assess a firm’s solvency prospects is not as straightforward as some courts argue. To do so, an expert must first pick a particular credit risk model from a host of choices which links the market evidence (or security price) to the likelihood of future default. Then, to implement his chosen model, the expert must estimate various parameter input values at the time of the alleged fraudulent transfer. In this connection, it is important to note that each credit risk model rests on particular assumptions, and there are typically several ways in which a model’s key parameters may be empirically estimated. Such choices critically affect any conclusion about a firm’s future default prospects as of the date of an alleged fraudulent conveyance.

Practical implications

Simply using market evidence does not necessarily eliminate the question of bias in any analysis. The reliability of a plaintiff’s claims regarding fraudulent conveyance will depend on the reasonableness of the analysis used to tie the observed market evidence at the time of the alleged fraudulent transfer to default prospects of the firm.

Originality/value

There is a large body of literature in financial economics that examines the relationship between market data and the prospects of a firm’s future default. However, there is surprisingly little research tying that literature to the analysis of fraudulent conveyance claims. Our paper, in part, attempts to do so. We show that while market-based methods use the information contained in market prices, this information must be supplemented with assumptions and the conclusions of these methods critically depend on the assumption made.

Details

Economic and Legal Issues in Competition, Intellectual Property, Bankruptcy, and the Cost of Raising Children
Type: Book
ISBN: 978-1-78560-562-8

Keywords

Book part
Publication date: 6 November 2012

Zhan Jiang, Kenneth A. Kim and Carl Hsin-Han Shen

Purpose – The relation between research and development (R&D) expenditures and bondholder wealth is examined.Methodology/approach – A sample of firms that increase R&D…

Abstract

Purpose – The relation between research and development (R&D) expenditures and bondholder wealth is examined.

Methodology/approach – A sample of firms that increase R&D expenditures is partitioned into two subsamples: firms with high default risk versus firms with low default risk. For each subsample, we examine the effect of R&D increases on bond returns and default risks.

Findings – For firms with high default risk, R&D increases have a negative impact on bond returns and default risk. Further, there is a wealth transfer from bondholders to stockholders surrounding R&D increases. Neither of these results is found for firms with low default risk.

Research limitations/implications – The present study highlights the importance of assessing firm's existing default risk to understand the effects that R&D expenditures have on bondholders.

Social implications – The study reveals a potential social welfare and economic cost, as it reveals that stockholders may be able to gain wealth at the expense of bondholders.

Originality/value – The study provides important insights to bondholders on how firms’ investment policies, such as R&D expenditures, may affect their wealth.

Details

Advances in Financial Economics
Type: Book
ISBN: 978-1-78052-788-8

Keywords

Article
Publication date: 10 October 2023

Guangping Liu, Kexin Zhou and Xiangzheng Sun

The aim of this study is to analyze the influence mechanism of real estate enterprises' status on debt default risk and explore the heterogeneity effect of the characteristics of…

Abstract

Purpose

The aim of this study is to analyze the influence mechanism of real estate enterprises' status on debt default risk and explore the heterogeneity effect of the characteristics of enterprises.

Design/methodology/approach

Against the background of the “three red lines” regulation of the financing of real estate enterprises and the COVID-19 pandemic, the authors select 123 real estate enterprises listed on China's Shanghai and Shenzhen A-shares markets from the first quarter of 2021 to the second quarter of 2022 as a research sample. The social network analysis method and Z-score financial risk early warning model are used to measure real estate enterprises' status and debt default risk. The authors construct a panel regression model to analyze how the status of real estate enterprises influences their debt default risk.

Findings

The results show that the status of real estate enterprises negatively and significantly affects their debt default risk. Economic policy uncertainty and financing constraints play negative moderating and mediating roles, respectively. Further research has found that the effect of real estate enterprises' status on debt default risk is characterized by heterogeneity in equity characteristics, i.e. it is significant in the sample of nonstate-owned enterprises but not in the sample of state-owned enterprises.

Practical implications

It is helpful for real estate enterprises to attach importance to the value of social networks, and the authors provide policy suggestions for real estate enterprises to constantly improve their risk management systems.

Originality/value

Using economic policy uncertainty as the moderating variable and financing constraints as the mediating variable, the authors analyze how the status of real estate enterprises influences debt default risk, which contributes to a better understanding of the formation of the debt default risk of real estate enterprises.

Details

Journal of Property Investment & Finance, vol. 42 no. 1
Type: Research Article
ISSN: 1463-578X

Keywords

Article
Publication date: 20 July 2023

Lingling Zhao, Vito Mollica, Yun Shen and Qi Liang

This study aims to systematically review the literature in the fields of liquidity, informational efficiency and default risk. The authors outline the key research streams and…

Abstract

Purpose

This study aims to systematically review the literature in the fields of liquidity, informational efficiency and default risk. The authors outline the key research streams and provide possible pathways for future research.

Design/methodology/approach

The study adopts bibliographic mapping to identify the most influential studies in the research fields of liquidity, informational efficiency and default risk from 1984 to 2021.

Findings

The study identifies four key research themes that include efficiency and transparency of markets; corporate yield spreads; market interactions: bonds, stocks and cryptocurrencies; and corporate governance. By assessing publications published from 2018 to 2021, the authors also document seven key emerging research trends: cross markets, managerial learning and corporate governance, state ownership and government subsidies, international evidence, machine learning (FinTech approaches), environmental themes and financial crisis. Drawing on these emerging trends, the authors highlight the opportunities for future research.

Research limitations/implications

Keyword searches have limitations since some studies might be overlooked if they do not match the specified search criteria, even though their relevance to the topic is under investigation. Adopt the R project to expand this review by incorporating more literature from other databases, such as the Scopus database could be a possible solution.

Practical implications

The four key research streams contribute to a comprehensive understanding of liquidity, informational efficiency and default risk. The emerging trends integrate existing knowledge and leave the chance for innovative research to expand the research frontier.

Originality/value

This study fulfills the systematic literature review streams in the fields of liquidity, informational efficiency and default risk, and provides fruitful opportunities for future research.

Details

Journal of Accounting Literature, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0737-4607

Keywords

Article
Publication date: 3 April 2017

Tsung-Ming Yeh

This study aims to provide additional insights by further investigating the governance aspects including board composition, risk monitoring and management by the board, ownership…

1122

Abstract

Purpose

This study aims to provide additional insights by further investigating the governance aspects including board composition, risk monitoring and management by the board, ownership structures as well as the incentive compensation.

Design/methodology/approach

This study investigates the relationships between corporate governance, risk-taking behaviors and default risk by analyzing 78 publicly listed Japanese regional banks during the 2007-2008 crisis period.

Findings

Banks that were more diversified in the run-up to the crisis were associated with higher default risk during the crisis. Foreign shareholders may have prompted banks to engage in higher risk-taking activities in pursuit of higher returns, putting banks at a higher risk of default. On the other hand, board-level risk management committees may have mitigated the risks to protect firms from rising default. Finally, banks perceived to have better quality accounting information, by being audited by one of the Big 4 auditors, benefitted by mitigating price misevaluation and thus reducing default risk during the crisis.

Originality/value

Different from the majority of previous related studies on the relationship between governance and performance of stock returns, the current study focuses on the relationship between governance and default risk during the crisis which has a more direct link through which governance practices can affect risk-taking behaviors and thus the default risk during the crisis. In addition to examining conventional governance aspects, this study also focuses on the more relevant aspects of banks’ risk monitoring functions.

Details

Corporate Governance: The International Journal of Business in Society, vol. 17 no. 2
Type: Research Article
ISSN: 1472-0701

Keywords

Article
Publication date: 1 February 2000

JEFFREY R. BOHN

This article surveys available research on the contingent‐claims approach to risky debt valuation. The author describes both the structural and reduced form versions of contingent…

Abstract

This article surveys available research on the contingent‐claims approach to risky debt valuation. The author describes both the structural and reduced form versions of contingent claims models and summarizes both the theoretical and empirical research in this area. Relative to the progress made in the theory of risky debt valuation, empirical validation of these models lags far behind. This survey highlights the increasing gap between the theoretical valuation and the empirical understanding of risky debt.

Details

The Journal of Risk Finance, vol. 1 no. 3
Type: Research Article
ISSN: 1526-5943

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