Are Corporates' Target Leverage Ratios Time-Dependent?
by Cho-Hoi Hui of the Hong Kong Monetary Authority
Abstract: This paper extends the stationary-leverage-ratio model to incorporate a time-dependent target leverage ratio. The theoretical hypothesis of the existence of a time-dependent target leverage ratio reflects the movement of a firm's initial target ratio toward a long-term target ratio over time. Using some simple scenarios about the time-dependence of the target leverage ratio, the numerical results show that the incorporation of the hypothesis into the stationary-leverage-ratio model is capable of producing term structures of probabilities of default that are consistent with some empirical findings. The results provide some evidences to support the hypothesis.
Keywords: Credit Risk Models, Credit Ratings, Default Probability.
Published in: International Review of Financial Analysis, Vol. 15, No. 3, (September 2006), pp. 220-236.
Previously titled: Estimation of Default Probability by Three-Factor Structural Model