
 Estimation of Default Probability by ThreeFactor Structural Model by ChoHoi Hui of the Hong Kong Monetary Authority, October 10, 2002 Abstract: This paper develops a threefactor structural model for estimating probability of default. The model incorporates the stochastic asset value of a corporate, liability and riskfree interest rate with timedependent model parameters. A corporate defaults when its leverage ratio increases above a predefined defaulttriggering level. Using average market data for corporates with different external credit ratings, the threefactor model is capable of producing the term structure of probabilities of default for rated corporates, that are broadly matched with the average default rates of the corresponding ratings reported by Standard & Poor's. The numerical results show that the estimation of probability of default is sensitive to the timedependent target leverage ratio. The threefactor model can be applied to the estimation of probability of default under the internal ratingsbased approach proposed in the New Basel Capital Accord. JEL Classification: G21, G28, G13. Keywords: Credit Risk Models, Credit Rating, Default Probability, Bank Regulation. 