## Assessing Default Risks for Chinese Firms: A Lost Cause?

_IMF Working Papers, June 26, 2015_

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## Bibliographic details
- Authors: Daniel Law, Shaun K. Roache
- Published: June 26, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513597584.001

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### Summary
- Assessing default risks for Chinese firms is hard.
- Standard measures of risk using market indicators may be unreliable because of implicit guarantees, the large role played by less-informed investors, and other market imperfections.
- The authors estimate stand-alone 1-year default probabilities for non-financial firms in China using an equity-based structural model and debt costs.
- Key conclusion: For individual firms, equity-based measures, while far from perfect, provide a better measure of stand-alone default risks than borrowing costs.

### Methodology
- Estimated stand-alone 1-year default probabilities for non-financial firms in China.
- Two approaches compared:
  - An equity-based structural model.
  - Measures based on debt costs.

### Key Findings
- Equity-measure sensitivity:
  - The equity measure of default risk is sensitive to a firm’s balance sheet health, profitability, and ownership.
  - Default probabilities are higher for weaker, less profitable, and state-owned firms.
- Debt-cost measures:
  - Measures based on the cost of debt seem largely detached from fundamentals.
  - Debt-cost measures appear instead determined by implicit guarantees.

### Policy Implications / Interpretation
- Implicit guarantees and market imperfections can make borrowing costs an unreliable indicator of firm-specific default risk in China.
- Equity-based measures capture firm fundamentals better than borrowing costs and therefore are preferred when assessing stand-alone default risks for individual firms, despite imperfections.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/assessing-default-risks-for-chinese-firms-a-lost-cause-43034_