B0210
Title: Corporate probability of default: A single-index hazard model approach
Authors: Shaobo Li - University of Kansas (United States) [presenting]
Shaonan Tian - San Jose State University (United States)
Yan Yu - University of Cincinnati (United States)
Xiaorui Zhu - University of Cincinnati (United States)
Heng Lian - City university of Hong kong (Hong Kong)
Abstract: Corporate probability of default (PD) prediction is vitally important for risk management and asset pricing. In search of accurate PD prediction, we propose a default-prediction single-index hazard model (DSI). The proposed semiparametric model is flexible and easy to interpret. It encompasses the linear hazard model and enjoys an appealing memoryless feature. Large sample properties are proved for the penalized spline approximation. By applying it to a comprehensive U.S. corporate bankruptcy database we constructed, we discover an interesting V-shaped relationship between the probability of default and the company's financial characteristics. The common discrete linear hazard specification is clearly violated, also confirmed by a simultaneous confidence band. Most importantly, the single-index hazard model passes the Hosmer-Lemeshow goodness-of-fit calibration test while neither does a state-of-the-art linear hazard model in finance nor a parametric class of Box-Cox transformation survival models. In economic value analysis, we find this may translate to as much as three times the profit compared to the linear hazard model. Furthermore, we reexamine the distress risk anomaly via the popular three- and five-factor asset pricing models. Based on the PDs from the proposed model, we find that the distress risk anomaly has weakened or even disappeared during the extended period, including the 2008 financial crisis.
