Oneadvantageofthisapproachisthatitcanbeextendedto
coverthelikelihoodofdistressatfirms withoutsignificant
debt.Forinstance,wecouldrelatethelikelihoodofdistressat
young technology firms to the cash burn ratio, which
measureshowmuchcashafirmhasonhandrelativetoits
operating cash needs.
13
Based on Bond Rating
Manyfirms,especiallyintheUnitedStates,havebondsthat
areratedfordefaultriskbytheratingsagencies.Thesebond
ratingsnotonlyconveyinformationaboutdefaultrisk(orat
leasttheratingsagency’sperceptionofdefaultrisk)butthey
comewith a richhistory.Sincebondshavebeenrated for
decades,wecanlookatthedefault experienceofbondsin
eachratingsclass.Assumingthattheratingsagencies have
not significantlyalteredtheirratingsstandards,we canuse
thesedefaultprobabilitiesasinputsintodiscountedcashflow
valuationmodels.AltmanandKishore(2001)haveestimated
thecumulativeprobabilitiesofdefaultforbondsindifferent
ratingsclassesover5-and10-yearperiods,andtheestimates
are reproduced inTable 17.1.
14 Aselaboration,thecumulativedefaultprobabilityforaBB
rated bond over 10 years is 16.89 percent.
15
TABLE 17.1 Bond Rating and Probability of Default,
1971–2001