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

Miguel Ampudia, Filippo Busetto and Fabio Fornari

No 2749, Working Paper Series from European Central Bank

Abstract: We test whether a simple measure of corporate insolvency based on equity return volatility -and denoted as Distance to Insolvency (DI) - delivers better prediction of corporate defaults 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 3 and 12 months. We illustrate the predictive power of the DI measure for the aggregate default rate by examining how corporate defaults would have evolved during the period marked by the spreading of the COVID-19 pandemic if DIs had not increased (so making future defaults less likely) also owing to the Eurosystem’s Public Emergency Purchase Program (PEPP). JEL Classification: C53, C58, G33

Keywords: default probability; distance to insolvency; equity volatility; expected default frequency (search for similar items in EconPapers)
Date: 2022-11
New Economics Papers: this item is included in nep-rmg
Note: 2445760
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20222749

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