Journal of Credit Risk

In this issue of The Journal of Credit Risk we present three full-length research papers and one technical report.

The issue's first paper, "Debt structure, market value of firm and recovery rate", is by Min Qi and Xinlei Zhao. In this paper the authors study the determinants of loss given default at the instrument, firm, industry and economy level. The authors propose a new variable, called seniority index, to incorporate the percentage of debt both more senior than and pari passu to the instrument under consideration. They find that it is very important to account for debt pari passu, as this new seniority index is the most important determinant of recovery rates or equivalently loss given default. Firm conditions, as measured by the trailing stock return of the firm, are the second most important determinant of recovery rates. For private firms, where market information is not available, industry and macro conditions can be informative. The authors do not find industry conditions to have a dominant role and their relative contribution varies with the sample, model specification and the modeling technique used.

Our second paper, "Counterparty risk subject to additional termination event clauses" by Richard Zhou, addresses the subject of the valuation of credit additional termination event clauses. The author clearly describes this clause and shows how it was designed to alleviate counterparty credit risk. The paper presents a practical method for evaluating bilateral credit value adjustment in the presence of additional termination events using rating transition matrix methodology. For joint defaults and rating transitions the author uses a normal copula model and demonstrates the importance of a bilateral approach.

The third paper in the issue is "Deriving consensus ratings of the big three rating agencies" by Bettina Grün, Paul Hofmarcher, Kurt Hornik, Christoph Leitner and Stefan Pichler. The paper addresses a key question that arises from the fact that S&P, Moody's and Fitch all issue ratings for the same firms: what is a "best consensus rating" if ratings differ for a particular firm? One could simply calculate the mean, but the authors present an alternative to derive a consensus rating. In an empirical study for the iTraxx Europe companies that are rated by the big three external rating agencies, the authors use Bayesian techniques to estimate the consensus ratings for these companies. They benchmark the results of their dynamic rating model to a naive one and illustrate the advantages of their methodology.

A technical report describes a particular practical technique and enumerates situations in which it works well and others in which it does not. Such reports provideextremely useful information to practitioners in terms of saved time and minimizing duplication of effort. The contents of technical reports complement rigorous conceptual and model developments presented in the research papers. A technical report can be a useful survey article as well.

In this issue's technical report, "The survival analysis approach in Basel II credit risk management: modeling danger rates in the loss given default parameter" by Stefano Bonini and Giuliana Caivano, survival analysis techniques are applied to the retail portfolio of an Italian bank in order to estimate the loss given default risk parameter by modeling danger rates. The authors analyze the use of a parametric survival model, where time is assumed to followsome distributions whose probability density function can be expressed in terms of two unknown parameters: hazard and shape.