A Credit Rating Method Based On Distance-to-Default Metrics And Prospect Value

Credit rating is an important thing for countries to occupy the rating voice,and it is the important tool for securing financial stability.With the development of China's opening up policy and the growing economy,it is necessary to study our own credit rating method.The distance to default method was originally proposed by KMV Company,which was registered by Kealhofer,McQuown and Vasicek.This method greatly promoted the development of the credit rating method,and gradually evolved into Moody's credit rating method,which has been widely used to assess credit risk nowadays.Moreover,many scholars have verified in practice that the distance to default can accurately quantify the credit risk of firms to a certain extent and has a good robustness.However,this thesis found that the distance to default method does not take into account the important functional relationship between the prospect of the credit subject and the safety level of credit risk in credit rating.In addition,Livingston pointed out that China's rating industry generally adopts the four-level rating scale,which has a certain gap with the international general rating scale.So there exists the weak correlation of rating standards and the rating period is usually unfixed.This thesis aims to realize a credit rating method which the rating information is more complete,objective,and the rating point is timely.On the basis of this,this thesis proposes the two-reference point prospect theory hypothesis and the distance to default based on prospect adjustment(PADD)rating method.The two-reference point prospect theory hypothesis assumes that as the credit risk security level(DD)of firm increases gradually,the prospect value(PS)corresponding to the distance to default(DD)presents the shape of asymmetric S-type loss avoidance function;However,when DD is sufficiently high,a prospect suppression reaction occurs which the PS value not only stops rising but gradually decreases to the lower limit of the prospect suppression at this time.Based on this assumption,this thesis selects the manufacturing industry to verify the performance of PADD model.The verification firstly uses market price fluctuations data,fundamentals,momentum,and analyst forecast data of listed companies' to calculate DD and PS.Then,the thesis constructs PS-DD benchmark function based on two-reference point prospect theory hypothesis,and rates with the calculated PADD value according to Basel II principle.Finally,this thesis introduces the rationality test index and verifies the effectiveness of PADD.In summary,the core value of PADD method proposed in this thesis lies in that the selection of data can be obtained directly from the commercial databases,which makes it possible to conduct non-subjective and timely credit rating for credit subjects,and it has an important application prospect in the future.