Modeling Credit Risk with Long-term and Short-term Debts

Author Name KOBAYASHI Takao  (Faculty Fellow) /IKEDA Ryoichi  (Graduate School of Economics, The University of Tokyo)
Creation Date/NO. June 2005 05-J-022
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This paper presents a new framework for valuating corporate credit risk using a balance sheet approach. Debt held by a company can be broadly classified into two categories: short-term debt that must be repaid within a relatively short period of time and long-term debt whose maturity period is relatively long. The greater the proportion of short-term debt to total debt, the greater the company's short-term credit risk. However, many existing risk valuation models have been unable to analyze credit risk based on the composition of the maturity periods because they assume all bonds and debentures are due on the same date. In this paper, we develop a model capable of simultaneously measuring both short-term and long-term credit risks, in which the short-term credit risk increases with the proportion of short-term debt to total debt, by inputting data on the two types of debt separately.

In the real world, a creditor often grants an extension of the repayment period to a defaulting debtor company. Our model assumes cases in which such extensions result in a rise in the price of bonds issued by the debtor company. When combined with the hypothesis that creditors maximize the overall value of their bond holdings, this model can provide varying degrees of credit risk depending on whether or not a company's provider of short-term and long-term credit is the same.