We assess the effectiveness of the Barra Default Probability (BDP) model in explaining the cross-sectional variation of Credit Default Spreads. In order to establish the usefulness of the BDP model in forecasting real-world defaults, we test it against historical default experience. We find that the model shows good default discriminatory power relative to agency ratings.

At Barra, we have developed a credit risk model for corprate issuers of debt.  One basic goal of our model is to forecast the default probability for firms that have publicly traded equity in addition to debt.  Initial statistical tests indicate that the Barra Default Probability (BDP) model performs significantly better than an agency-ratings based system.  In this article, we will give a brief outline of the model and the statistical testing.  Until recently, there have...