The material on this site is for financial institutions, professional investors and their professional advisers. It is for information only. Please read our Terms & Conditions, Privacy Policy and Cookies before using this site. Please see our Subscription Terms and Conditions.


All material subject to strictly enforced copyright laws. © 2021 Euromoney, a part of the Euromoney Institutional Investor PLC.

A model is simply a tool

Bankers and investors putting on debt versus equity trades are drawing on the idea first expounded by Nobel economics laureate Robert Merton that equity can be thought of as a call option on the assets of a firm. If the share price dips below a certain level - implying a lower value on the firm's assets and cashflows relative to its liabilities - default will follow. Bondholders, meanwhile, have sold an equity put option to the issuer and the spread on a corporate bond is the premium for taking that position.

KMV has popularized this theory over the past 10 years with its model providing - for a fee - an estimated default frequency (EDF) measure for corporates based on its proprietary database of historical default data. So the market was already attuned to this idea when CreditGrades - by Riskmetrics, with the backing of Goldman Sachs, JPMorgan and Deutsche Bank - was launched in June.

According to Jorge Mina, head of risk modelling at Riskmetrics, CreditGrades improve on KMV both in terms of being more transparent and more user-friendly. "The big difference is that certain parts of KMV, such as the historical database of default probabilities, are not market observable," he says.

You have reached premium content. Please log in to continue reading.

Read beyond the headlines with Euromoney

For over 50 years, our readers have looked to Euromoney to stay informed about the issues that matter in the international banking and financial markets. Find out more about our different levels of access below.

SUBSCRIBE ONLINE TODAY

Unlimited access to Euromoney.com and Asiamoney.com

Expert comment, long reads and in-depth analysis interviews with senior finance professionals

Access the results of our market-leading annual surveys across core financial services

Access the results of our annual awards, including the world-renowned Awards for Excellence

Your print copy of Euromoney magazine delivered monthly

£73.75 per month

Billed Annually

FREE 7 DAY TRIAL

Unlimited access to Euromoney.com and Asiamoney.com, including our top stories, long reads, expert analysis, and the results of our annual surveys and awards

Sign up to any of our newsletters, curated by our editors

LOGIN NOW

Already a user?

We use cookies to provide a personalized site experience.
By continuing to use & browse the site you agree to our Privacy Policy.
I agree