How do you interpret Probability of default?

Answer 1

Distance-to-Default:-

- distance between the expected value of the asset and the default point

- after substitution into a normal c.d.f one gets probability of default

DD(t) =ln(V/F)+(µ-0.5*σ^2)*T/(σ*sqrt(T));

Where, V= value of the assets

F=Value of the liability/debt

µ= expected return of assets

σ=Volatility of the assets

T= Time

And Probability of default:-

PD(t) = NormDist(-DD)= Ɲ(-DD)