Search Results (16)

This study, within the framework of uncertainty theory, employs an uncertain differential equation with jumps to model the asset value process of a company, establishing a structured model of uncertain credit risk that incorporates jumps. This model is applied to the pricing of two types of credit derivatives, yielding pricing formulas for corporate zero-coupon bonds and Credit Default Swap (CDS). Through numerical analysis, we examine the impact of asset value volatility and jump magnitude on corporate default uncertainty, as well as the influence of jump magnitude on the pricing of zero-coupon bonds and CDS. The results indicate that an increase in volatility levels significantly enhances default uncertainty, and an expansion in the magnitude of negative jumps not only directly elevates default risk but also leads to a significant increase in the value of zero-coupon bonds and the price of CDS through a risk premium adjustment mechanism. Therefore, when assessing corporate default risk and pricing credit derivatives, the disturbance of asset value jumps must be considered a crucial factor. Full article

Chonsei, a Korean housing lease system, enables landlords to acquire direct housing purchase funds without mortgages and offers tenants a cost-effective rental option. However, public concerns have arisen about potential landlord defaults, causing financial distress for tenants. This study examined the risk of non-return of the Chonsei deposit and developed a default prediction model using Chonsei contract data from the Korea Housing and Urban Guarantee Corporation. Starting with the components from Merton’s bond pricing model, we included variables that reflect contract-specific factors, macroeconomic conditions, and the Korean Chonsei practices. The findings revealed that higher house price volatility, elevated debt-to-house value, and risk-free interest rates positively correlate with non-return risk. Meanwhile, certain factors, such as longer remaining maturity, favorable macroeconomic conditions, and rising market Chonsei price trends, demonstrated negative correlations with non-return risk. Consequently, a logistic regression-based default prediction model, with eight risk factors that predict the deposit non-return, was suggested. By identifying risk factors and predicting the non-return risk of deposits, this study contributes to an informed policy decision in planning and practicing Chonsei contracts in the Korean housing market. Full article

This study aims to investigate the relationship between creditor protection and the debt maturity structure of corporations in the Gulf Cooperation Council (GCC) countries. The GCC countries enjoy large GDPs, growing capital markets, especially the Islamic bonds (Sukuk) market, and negligible tax environments. Nonetheless, the GCC countries’ financial systems are still dominated by banks, and their private investments are held by concentrated investors. The study utilizes firm-level financial data and country-level institutional data obtained from the World Bank Governance Indicators and Doing Business databases and applies the two-stage least square estimator to test its hypotheses. The findings indicate that stronger regulatory effectiveness is associated with long debt maturities, while better creditor protection is associated with short debt maturities. The latter finding suggests that managers and owners have incentives to utilize short-term debt in economies characterized by stronger liquidation and insolvency rules to avoid the loss of control in the case of a firm default. This finding has policy implications in terms of the importance of considering the dual influence of institutional reforms on the supply of and demand for long-term capital. Full article

Debt financing is related to borrowing funds from enterprises and investors through bonds, banks, or financial institutions. Interest in debt financing has been rapidly growing in recent years and is now considered one of the most common ways an enterprise can increase its capital to run its business. However, the use of a large amount of debt is associated with the management of corporate indebtedness, requiring the tracking of the entire financial performance of the company. The chief objective of this study was to determine and assess the indebtedness level of enterprises operating in the Slovak Republic using 12 crucial debt ratios and then to clarify whether there are statistically relevant dissimilarities in corporate debt as a result of the firm size and its legal form, representing relevant company-specific features having an impact on corporate indebtedness. Subsequently, a more elaborate analysis addressing statistically relevant dissimilarities between separate indebtedness ratios in relation to the size of the company and its legal form was carried out by deploying the nonparametric Kruskal–Wallis test. We leveraged the Bonferroni correction to specify where stochastic ascendancy occurs. The Kruskal–Wallis test result revealed statistically significant dissimilarities in the values of debt ratios as a result of the firm size and the legal form of the company, which confirmed previous results indicating the most relevant determinants shaping corporate debt. Recognizing the repercussions of firm size and legal form on the corporate debt policy plays an important role, as these company-specific features may be perceived as proxies for the default likelihood or for the volatility of corporate assets, making the regulatory process of creditors and stakeholders straightforward. The findings confirmed the theories of numerous researchers who claimed that firm size and legal form are critical aspects of corporate debt. Full article

The economic growth of China has been driven by the development of its real estate market, especially after the 2008 crisis. This growth is mostly related to the huge housing bubble and growing amounts of sovereign debt that have been redirected to corporations in the sector. Evergrande is one of those corporations; it is a Chinese company in the construction and real estate sector, a global giant with investments in many parts of the world. Its bond default in September 2021 sounded alerts in financial markets. Several news outlets spoke of the “next Lehman Brothers”, and apprehension was very high, especially in Asian markets. This research work aims to evaluate the impact of Evergrande’s bond default on six Asian stock markets, using an event study approach. The results show a strong reaction from the markets towards the event in study, even anticipating it. Furthermore, it is worth mentioning a quick reversion to “normal” behavior, indicating the rapid absorption of information by the markets. Full article

We apply Geometric Arbitrage Theory (GAT) to obtain results in mathematical finance for credit markets, which do not need stochastic differential geometry in their formulation. The remarkable aspect of the GAT is the gauge symmetry, which can be translated to the financial context, by packaging all of the asset model information into a (stochastic) principal fiber bundle. We obtain closed-form equations involving default intensities and loss-given defaults characterizing the no-free-lunch-with-vanishing-risk condition for government and corporate bond markets while relying on the spread-term structure with default intensity and loss-given default. Moreover, we provide a sufficient condition equivalent to the Novikov condition implying the absence of arbitrage. Furthermore, the generic dynamics for an isolated credit market allowing for arbitrage possibilities (and minimizing the total quantity of potential arbitrage) are derived, and arbitrage credit bubbles for both base credit assets and credit derivatives are explicitly computed. The existence of an approximated risk-neutral measure allowing the definition of fundamental values for the assets is inferred through spectral theory. We show that instantaneous bond returns are serially uncorrelated and centered, that the expected value of credit bubbles remains constant for future times where no coupons are paid, and that the variance of the market portfolio nominals is concurrent with that of the corresponding bond deflators. Full article

This article introduces a new approach for dealing with the diversification/concentration risk of fixed income assets. Because Government bonds, corporate bonds, and mortgage backed securities constitute a large proportion of the assets of institutional investors in most countries, it is important to be able to determine the number of lines/issuers of such assets, not only for portfolio management but also for risk management purposes. The approach that I introduce shows the dependence of the critical number of lines of fixed income assets on the main interest rate risk and credit risk drivers. Specifically, I examine the importance of volatility risk, force of mean reversion, default risk, recovery risk, and default dependence risk on the critical number of assets in a fixed income portfolio. The methodology in this paper relies on the use of the coefficient of variation for the computation of the critical number of credit-sensitive securities in a fixed income portfolio. To the best of my knowledge, this paper is the first to develop such an approach. Full article

Credit risk modeling by debt pricing has been a popular theme in both academia and practice since the subprime crisis. In this paper, we devote our study to the indifferent price of a corporate bond with credit risk involving both default risk and credit rating migration risk in an incomplete market. The firm’s stock and a financial index on the market as tradable assets are introduced to hedge the credit risk, and the bond price is determined by the indifference of investors’ utilities with and without holding the bond. The models are established under the structural framework and result in Hamilton–Jacobi–Bellman (HJB) systems regarding utilities subject to default boundary and multiple migration boundaries. According to dynamic programming theory, closed-form solutions for pricing formulas are derived by implementing an inverted iteration program to overcome the joint effect of default and multiple credit rating migration. Therefore, with the derived explicit pricing formulas for the corporate bond, the models can be easily applied in practice, and investors can generate their strategies of hedging the credit risk by easily analyzing the impacts of the parameters on the bond price. Full article

Capturing determinants of bond default risks has aroused heated discussions ever since the “rigid payment” system collapsed in China. Within this context; this paper aims to clarify the relation between an issuer’s environmental; social; and corporate (ESG) performance and its bond default rate. We developed an ESG factors-embedded Logistic Regression model to empirically examine Chinese default bonds and outstanding industrial bonds from 2014 to 2019. Results indicate that the bond default rate is positively correlated with the company’s energy consumption and negatively correlated with its attention to social responsibilities; and corporate governance; in addition to its financial performances. In conclusion; to fully take ESG factors into consideration during the decision-making process and daily operations might improve stability and credibility of corporations in modern Chinese national context. Full article

In recent years, researchers have been devoted to illustrating the correlation between bankers’ pay contracts and a bank’s risk-taking behavior where corporate governance is concerned, especially throughout the past four decades and by using empirical analysis. Despite being a widespread concern, the causality of this relationship is not thoroughly understood. We initiate this research by modeling bankers’ multi-stage decisions of option investment and bond investment from the perspective of theoretical analysis, and by analyzing the function image results using data from Wells Fargo & Co. from the ExecuComp, BvD Orbis, and CRSP-COMPUSTAT databases. We aim to deeply explore the mechanism of how compensation influencing on risk. We are the first to find that it has a “risk cap”, which is the optimal risk level to maximize the return of decision-making. We are also the first to discover the optimal decision coefficient level to maximize the decision return, during which the internal causes and mechanisms of the impact of bankers’ compensation on a bank’s default risk are revealed. We also illustrate the influence of the number of periods. We expect our findings to provide advice for establishing policies when designing pay contracts. Full article

Using an aggregate credit spread index, we find that it has substantial predictive power for corporate bond returns over short and long horizons. The return predictability is economically and statistically significant and robust to various controls. The credit spread index and its components have more predictive power for bond returns than conventional default and term spreads. When decomposing the credit spread index into investment- and speculative-grade components, the latter has more predictive power for future bond returns. The source of the index’s predictive power is from its ability to forecast future economic conditions. Full article

Corporate bond defaults in different sectors often increase suddenly at roughly similar times, although some sectors see default rates jump earlier than others. This could reflect contagion among sectors—specifically, defaults in one sector leading to credit stresses in other sectors of the economy that would not otherwise have seen stresses. To complicate matters, simple correlation-based tests for contagion are often biased, reflecting increased volatility in periods of stress. This paper uses sectoral default data from over 30 sectors to test for signs of contagion over the past 30 years. While jumps in sectoral default rates do often coincide, there is no consistent evidence of contagion across different periods of stress from unbiased test results. Instead, coincident jumps in sectoral default rates are likely to reflect common macroeconomic shocks. Full article

Measures of corporate credit risk incorporate compensation for unpredictable future changes in the credit environment and compensation for expected default losses. Since the launch of purchases of government securities and corporate securities by the European Central Bank, it has been discussed whether the observed reduction in corporate credit risk was due to the decrease in risk aversion favored by the monetary easing or by expectations of lower losses due to corporate defaults. This work introduces a new methodology to break down the factors that drive corporate credit risk, namely the premium linked to cyclical and monetary conditions and that linked to the restructuring of the companies. Untangling these two components makes it possible to quantify the drivers of excess returns in the corporate bond market. Full article

A large proportion of the academic literature about the agency problem focuses on corporate governance or the instruments that can be used to balance the incentives of shareholders and debt holders. Following the real options company valuation framework, one method to increase shareholder value involves increasing the intrinsic risk of the firm; however, such a practice reduces the bondholder value. We analyzed an innovative balance sheet instrument, the mandatory convertible bond, as a means to increase financial sustainability of companies, improving the value for shareholders without increasing the perceived default risk. The results of the empirical analysis illustrate that for companies in a weak credit position, the agency problem can be mitigated by the issuance of mandatory convertible bonds, which allows managers to increase company risk without being detrimental for bondholders. However, when the probability of distress is small, shareholders have less incentive to increase company risk than in a company funded by mandatory convertible bonds, being more aligned with bondholders. A better alignment of debt holders and shareholders incentives reduces inefficiencies, mitigates the probably of distress, and improves the long-term financial sustainability of companies and can promote stable growth and innovation. Full article

Undoubtedly, it is important to have an empirically effective credit risk rating method for decision-making in the financial industry, business, and even government. In our approach, for each corporate bond (CB) and its issuer, we first propose a credit risk rating (Crisk-rating) system with rating intervals for the standardized credit risk price spread (S-CRiPS) measure presented by Kariya et al. (2015), where credit information is based on the CRiPS measure, which is the difference between the CB price and its government bond (GB)-equivalent CB price. Second, for each Crisk-homogeneous class obtained through the Crisk-rating system, a term structure of default probability (TSDP) is derived via the CB-pricing model proposed in Kariya (2013), which transforms the Crisk level of each class into a default probability, showing the default likelihood over a future time horizon, in which 1545 Japanese CB prices, as of August 2010, are analyzed. To carry it out, the cross-sectional model of pricing government bonds with high empirical performance is required to get high-precision CRiPS and S-CRiPS measures. The effectiveness of our GB model and the S-CRiPS measure have been demonstrated with Japanese and United States GB prices in our papers and with an evaluation of the credit risk of the GBs of five countries in the EU and CBs issued by US energy firms in Kariya et al. (2016a, b). Our Crisk-rating system with rating intervals is tested with the distribution of the ratings of the 1545 CBs, a specific agency’s credit rating, and the ratings of groups obtained via a three-stage cluster analysis. Full article