Modeling credit risk and corporate debt securities
This chapter provides some time-series evidence on loan and bond defaults, recovery rates, and credit spreads and interprets their relationship to business cycles. We describe the ratings conventions, the migration of firms from one rating category to another, and the difference between investment-grade and noninvestment-grade debt. We explain structural and reduced-form models of default and illustrate their applications in valuing corporate debt securities. We explain how default probabilities can be computed using equity prices and structural models of default. The relationship between the spreads of senior and subordinated debt is derived in a structural context and ...