A Simple Empirical Model of Equity-Implied
Probabilities of Default

Abstract

In this article, the authors approximate the likelihood of default inferred from equity prices using accounting-based measures, firm characteristics, and industry-level expectations. Such empirical approximations enable the timely modeling of distress risk in the absence of equity prices or sufficient historical records of defaults. Through a series of re-sampling experiments, the authors show that their models deliver out-of-sample classification performance comparable to that of default likelihood inferred from equity prices using the Black–Scholes–Merton framework. Furthermore, they document the distinct roles of firm-level and macroeconomic information in capturing time-varying exposure to the risk of financial distress. More generally, the results underscore the importance of treating equity-implied default probabilities and fundamental variables as complementary rather than competing sources of predictive information.