RiD: A New Approach to Estimate the Insolvency Risk

• Main Authors: Marco Aurélio dos Santos Sanfins, Danilo Soares Monte-Mor
• Format: Article
• Language: English
• Published: Brazilian Society of Finance 2014-10-01
• Series: Revista Brasileira de Finanças
• Subjects: Insolvency Risk; credit risk; Monte Carlo simulation
• Online Access: http://bibliotecadigital.fgv.br/ojs/index.php/rbfin/article/viewFile/18543/33956

Given the recent international crises and the increasing number of defaults, several researchers have attempted to develop metrics that calculate the probability of insolvency with higher accuracy. The approaches commonly used, however, do not consider the credit risk nor the severity of the distance between receivables and obligations among different periods. In this paper we mathematically present an approach that allow us to estimate the insolvency risk by considering not only future receivables and obligations, but the severity of the distance between them and the quality of the respective receivables. Using Monte Carlo simulations and hypothetical examples, we show that our metric is able to estimate the insolvency risk with high accuracy. Moreover, our results suggest that in the absence of a smooth distribution between receivables and obligations, there is a non-null insolvency risk even when the present value of receivables is larger than the present value of the obligations.