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Donald van Deventer
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Donald R. van Deventer founded the Kamakura Corporation in April, 1990 and is currently Chairman and Chief Executive Officer. Dr. van Deventer's emphasis at Kamakura Corporation is enterprise wide risk management and modern credit risk technology. The second edition of his newest book, Advanced... More
My company:
Kamakura Corporation
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My book:
Advanced Financial Risk Management, 2nd Edition 2013
  • Molycorp 1 Year Default Probability Drops 1.13% Today To 4.35% 6 comments
    Aug 12, 2014 1:37 PM | about stocks: IQ

    (click to enlarge)mcp

    The blue line is the firm's one year default probability. The yellow line is the annualized one month default probability.

    Background on the Default Probability Models Used

    The Kamakura Risk Information Services version 5.0 Jarrow-Chava reduced form default probability model (abbreviated KDP-jc5) makes default predictions using a sophisticated combination of financial ratios, stock price history, and macro-economic factors. The version 5.0 model was estimated over the period from 1990 to 2008, and includes the insights of the worst part of the recent credit crisis. Kamakura default probabilities are based on 1.76 million observations and more than 2000 defaults. The term structure of default is constructed by using a related series of econometric relationships estimated on this data base. KRIS covers 35,000 firms in 61 countries, updated daily. Free trials are available at Info@Kamakuraco.com. An overview of the full suite of Kamakura default probability models is available here.

    Using Default Probabilities in Asset Selection

    We recommend this introduction to the use of default probabilities in fixed income strategy by J.P. Morgan Asset Management.

    General Background on Reduced Form Models

    For a general introduction to reduced form credit models, Hilscher, Jarrow and van Deventer (2008) is a good place to begin. Hilscher and Wilson (2013) have shown that reduced form default probabilities are more accurate than legacy credit ratings by a substantial amount. Van Deventer (2012) explains the benefits and the process for replacing legacy credit ratings with reduced form default probabilities in the credit risk management process. The theoretical basis for reduced form credit models was established by Jarrow and Turnbull (1995) and extended by Jarrow (2001). Shumway (2001) was one of the first researchers to employ logistic regression to estimate reduced form default probabilities. Chava and Jarrow (2004) applied logistic regression to a monthly database of public firms. Campbell, Hilscher and Szilagyi (2008) demonstrated that the reduced form approach to default modeling was substantially more accurate than the Merton model of risky debt. Bharath and Shumway (2008), working completely independently, reached the same conclusions. A follow-on paper by Campbell, Hilscher and Szilagyi (2011) confirmed their earlier conclusions in a paper that was awarded the Markowitz Prize for best paper in the Journal of Investment Management by a judging panel that included Prof. Robert Merton.

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Stocks: IQ
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  • Cordycep
    , contributor
    Comments (48) | Send Message
     
    So where will the Pentagon get it REE ? Chinese?
    12 Aug 2014, 02:24 PM Reply Like
  • Donald van Deventer
    , contributor
    Comments (2090) | Send Message
     
    Author’s reply » Good question, but I can't even predict what I'm having for dinner this evening.
    12 Aug 2014, 04:03 PM Reply Like
  • SECInformant
    , contributor
    Comments (6) | Send Message
     
    "In this paper we consider the measurement and pricing of distress risk. We present a model of corporate failure in which accounting and market-based measures forecast the likelihood of future financial distress. Our best model is more accurate than leading alternative measures of corporate failure risk. We then use our measure of financial distress to examine the performance of distressed stocks from 1981 to 2008. We Önd(?) that distressed stocks have highly variable returns and high market betas and that they tend to underperform safe stocks by more at times of high market volatility and risk aversion. However, investors in distressed stocks have not been rewarded for bearing these risks. Instead, distressed stocks have had very low returns, both relative to the market and after adjusting for their high risk. The underperformance of distressed stocks is present in all size and value quintiles. It is lower for stocks with low analyst coverage and institutional holdings, which suggests that information or arbitrage-related frictions may be partly responsible for the underperformance of distressed stocks." Does this mean that MCP is not ripe for a turnaround takeover artist to sieze the day?
    21 Aug 2014, 02:25 PM Reply Like
  • Donald van Deventer
    , contributor
    Comments (2090) | Send Message
     
    Author’s reply » The quote you've picked up is one of my favorites. It's relevant to the pool of distressed stocks, not any one stock. We're posting a few MCP instablogs in the next hour. Bond market participants seem much more pessimistic than the equity participants.
    21 Aug 2014, 05:20 PM Reply Like
  • SECInformant
    , contributor
    Comments (6) | Send Message
     
    "The UniTed STaTeS is a nation of debtors. By the end of 2007, total debt outstanding by households, businesses, state and local governments, and the federal government added up to $31.2 trillion.

     

    (Commenter NB: "Global Debt Issue Exceeds $1,000,000,000,000,000 as of 2014":)

     

    "The domestic financial sector accounted for half of this total, or $15.8 trillion.

     

    "The size of the debt market is quite large. Indeed, it ex- ceeds both the U.S. GDP in 2007 ($13.8 trillion) and the equity market value of all domestic corporations ($15.5 trillion).1 The primary risk of all this debt is credit risk, or the risk of default. The current credit crisis demonstrates how shifts in credit spreads and market liquidity can also significantly impact debt values. Although these alterna- tive factors are important for understanding debt markets, we will focus here only on default risk.

     

    "Investors measure default risk in many different ways, and there have been important recent innovations in this regard.

     

    "The state of the art in assessing corporate credit risk is based on one of three approaches: 1) the Merton distance-to-default measure, 2) the reduced-form ap- proach, and 3) credit ratings. We will compare and con- trast these three approaches, showing that the reduced- form approach is preferred because of its generality, flexibility, and superior forecasting ability."

     

    Q1. What is MCP's distance to default measure?
    Q2. What is MCP's reduced form approach answer?
    Q3. Which credit agencies have rated MCP's debt and how accurate are these rating agencies in light of their failures in the MBS market over the past decade?
    Q4. If all creditors of MCP converted their holdings in due course to equity would the company be able to pay any dividends out of current cash flow?
    23 Aug 2014, 01:22 PM Reply Like
  • Donald van Deventer
    , contributor
    Comments (2090) | Send Message
     
    Author’s reply » A1. We have that on our KRIS service but we don't report on SA because distance as default is now recognized as an inaccurate measure of default risk. See the Campbell 2008 and Bharath and Shumway paper 2008 for independent confirmation.
    A2. Those are the default probabilities given in the post.
    A3. We don't report ratings because we think in general their level of accuracy is too low. See this paper by Hilscher and Wilson for a study in that regard: http://bit.ly/YOopwe
    A4. That's a good question but beyond the scope of this post. Thanks for your long comment.
    23 Aug 2014, 05:44 PM Reply Like
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