We consider an independent private value model. N risk-neutral firms compete to win 7 a contract. At the time of bidding, for any bidder i the expected cost of completing the 8 project is: c = x + y + θε, where x is a privately observed cost, y and are commonly 9 observed costs with 0 < ε < y and θ, 0 < θ < 1, is the probability that the contract will 10 be expensive to complete. Whether the co...

The recent string of accounting scandals highlights the need for bond investors to reconsider the informational assumptions underlying traditional models of default. In these models it is implicitly assumed that the information used to calibrate and run the model is publicly available. In reality, model inputs and parameters are uncertain. We develop a class of cause and effect default models b...

We examine the default probabilities predicted by “structural” models of risky corporate debt. Two types of models are examined: those with “exogenous” default boundaries, typified by Longstaff and Schwartz (1995); and those with “endogenous” default boundaries, typified by Leland and Toft (1996). We focus on default probabilities rather than credit spreads because (i) they are not affected by ...

Credit ratings are commonly used by lenders to assess the default risk, because every credit is connected with a possible loss. If the probability of a default is above a certain threshold, a credit will not be provided. The purpose of this paper is to test whether credit ratings contribute valuable information on the creditworthiness of firms. Employing a large sample of Western German manufac...

The recent accounting scandals at Enron, WorldCom, and Tyco were related to the misrepresentation of liabilities. We provide a structural model of correlated multi-firm default, in which public bond investors are uncertain about the liability-dependent barrier at which individual firms default. Investors form prior beliefs on the barriers, which they update with the default status information o...

We develop a model of lending and borrowing in markets where the lender has no access to physical collateral and where the borrower is heavily capital constrained. Our model of micro loans, which incorporates a) the absence of access to physical collateral, b) peer monitoring, c) threat of punishment upon default, and d) costly monitoring by lenders is used to determine the equilibrium borrowin...

Using credit default swaps (CDS) to imply a …rm’s or sovereign’s default probability is laden with di¢ culties, making the resulting estimate unreliable. This paper exposes these di¢ culties using a simple analogy to life insurance premiums. An analogy is used because the logic is more easily understood in this context. The di¢ culties are unraveling the impact of risk premium, counterparty ris...

We study the effect of incorporating heterogeneity into default rules by examining the choice between retirement plans at a firm which transitioned from a defined benefit (DB) to a defined contribution (DC) plan. The default plan for existing employees varied discontinuously depending on their age. Employing regression discontinuity techniques, we find that the default increased the probability...

We provide maximum likelihood estimators of term structures of conditional probabilities of corporate default, incorporating the dynamics of firm-specific and macroeconomic covariates. For U.S. Industrial firms, based on over 390,000 firm-months of data spanning 1979 to 2004, the level and shape of the estimated term structure of conditional future default probabilities depends on a firm’s dist...

Credit default swaps (CDSs) are thought to ease borrowing by protecting lenders against default. This paper develops a model of the demand for CDS when borrowers choose the riskiness of investment and verification is imperfect. The model shows that CDSs may lead to risk-shifting, increasing the probability of default. Our model provides new insights on the role of CDS during the recent financia...