Hans Byström: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden, and, School of Finance and Economics, University of Technology, Sydney, P.O.Box 123, Broadway, NSW 2007, Australia
Abstract: The growing interest in management of credit risk and estimation ofdefault probabilities has given rise to a range of more or lesselaborate credit risk models. Hall and Miles (1990) suggests an approachof estimating failure probabilities based solely on stock market prices.The approach has the advantage of simplicity but relies on markete.ciency to hold. In this paper we suggest an extension to the Hall andMiles (1990) model using extreme value theory and apply the extendedmodel to the Swedish financial sector and to individual Swedish banks.The 15- year long sample in our study covers the period of the Swedishbanking crisis of the early 1990s. We find a close correspondencebetween changes in the estimated probabilities of failure and the actualcredit events occurring. Credit ratings from major credit ratingagencies, on the other hand, are shown to react much less and muchslower to credit quality changes.
28 pages, March 11, 2003
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