DiBartolomeo (2010)

DiBartolomeo, Dan.  “Equity Risk, Credit Risk, Default Correlation and Corporate Sustainability.”  Working paper (Northfield Information Systems), 2010.  

From the introduction:  "Starting with Merton (1974), financial researchers have long understood the theoretical links between equity risk and credit risk. While “structural models” of credit risk such as Moody’s-KMV have been available for some time, we have developed a new approach for the use of such models. In our approach, we derive the market-implied expected life of a firm based on the firm’s stock price, balance sheet leverage and the equity risk forecast from our models. We first translate the equity risk forecast into a forecast of volatility of a firm’s assets. An option framework similar to Merton (1974) and Leland (1994) is then used to derive an expectation of market implied expiration date of the option, which is a proxy for expected life of the firm. Two methods for improving estimates of default correlation are provided. We will also show empirical uses of the technique at both the firm level as a measure of credit risk and at the market level as a metric for systemic risk. Finally, we will also present evidence that the concept of corporate “sustainability” as broadly used by socially responsible investors appears to be supported, with purportedly sustainable firms having average expected lives which are longer than those of non- sustainable firms to a statistically significant degree."


Link (slide presentation):  http://www.northinfo.com/documents/405.pdf