Chronicle of a death foretold: does higher volatility anticipate corporate default?

Miguel Ampudia (), Filippo Busetto () and Fabio Fornari ()
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Miguel Ampudia: Bank for International Settlements
Filippo Busetto: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Fabio Fornari: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 1001, Bank of England working papers from Bank of England

Abstract: We test whether a simple measure of corporate insolvency based on equity return volatility – and denoted as Distance to Insolvency (DI) – delivers better predictions of corporate default than the widely-used Expected Default Frequency (EDF) measure computed by Moody’s. We look at the predictive power that current DIs and EDFs have for future defaults, both at a firm-level and at an aggregate level. At the granular level, both DIs and EDFs anticipate corporate defaults, but the DI contains information over and above the EDF, especially at longer forecasting horizons. At an aggregate level the DI shows superior forecasting power compared to the EDF, for horizons between three and twelve months. We illustrate the predictive power of the DI measure by examining how corporate defaults would have evolved during Covid-19 had the ECB not implemented the pandemic emergency purchase programme (PEPP).

Keywords: Default probability; equity volatility; Distance to Insolvency; Expected Default Frequency (search for similar items in EconPapers)
JEL-codes: C53 C58 G33 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2022-10-28
New Economics Papers: this item is included in nep-cfn and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:1001

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