Advancing the Field of Quantitative Finance
formerly the IAFE


Event: Are Equity Markets Complete and Sufficient to Predict Default Probabilities?
Date: November 18
Time: 5:30 pm registration begins. 6 pm program begins. Reception at 7:15 pm.
Goldman Sachs
32 Old Slip


Are Equity Markets Complete and Sufficient to Predict Default Probabilities?

Sponsored by Financial Risk Management and SunGard Trading & Risk Systems

The ability to correctly model the default problability of an obilgor is both a hot topic in finance theory and a topic of great practical importance for firms. An obligor's estimated PD will effect the limit on how much it can borrow from a bank as well as its cost of credit. In addition, under Basel II, PD estimates are a key parameter in the calculation of the risk weight assigned to a loan.

A widespread approach to estimating default probability rest on the insight of Merton that shareholders hold an effective call option on the assets of the firm. From this insight, structural (options) models can be built that estimate the default probability of an obligor as a function of the price of its equity, the historic or implied volatility of its equity and its capital structure.

An alternative approach argues that equity market prices reflect not only the credit worthiness of a firm but also unrelated information such as changes in the market participants' appetite for risk, liquidity risk, uncertainty about the economy, and supply and demand effects. This would suggest that equity prices are insufficient to accurately estimate the PD of an obligor. One alternative is to model obligor's default probability by a "hybrid model" that integrates equity market and financial statement data with other relevant information.

This discussion will focus on the theoretical and empirical data supporting either approach.

Speakers include:

Dale F. Gray, President, Macro Financial Risk, Inc.
Stephen Kealhofer, Moody's KMV
Robert Selvaggio, Managing Director/Head, Risk Analysis and Reporting Structured Credit Risk Analytics, Ambac
Jorge Sobehart, Vice President - Senior Analyst, Risk Analytics, Citigroup Risk Architecture

Moderated by:
Evan Picoult, Managing Director, Citigroup Risk Architecture