In the recent PNAS paper
http://bit.ly/uI1nxG one can read that prevailing economic models of credit risk assume that price fluctuations form a bell-shaped curve, with very large fluctuations essentially never occurring. But during financial crises,
wild fluctuations occur more frequently than these models predict. Authors developed a method to incorporate these fluctuations in their analysis of financial data from 488 publicly traded manufacturing firms for each quarter from 2000–2009. The researchers used multiple types of known calculations to analyze financial data such as the ratio of working capital to total assets, and sales divided by total assets. These data were plugged into multiple ratio calculations to estimate credit risk for the companies. Particular attention was paid to the years 2007–2009, a time of overall financial crisis. According to the authors, the results suggest that even during stock market crashes, the basic dynamics that underlie less volatile periods still govern credit risk. The study revealed that credit risk follows slowly decaying functional form,
implying that dangerous credit positions are more likely than is commonly believed. According to the authors, the credit rating approach may help improve the estimation of credit risk, particularly in the event that financial services companies respond slowly to changes in corporate credit quality.
