Catching Fallen Angels (and Other Expensive Credit Events)

Abstract

We examine the efficacy of the I-squared incomplete information credit model in a broad context that is relevant to fund and asset managers. Using a rigorous statistical analysis, we show that I-squared is a powerful forecaster of the following events: - Rating agency downgrades - Investment grade to high yield downgrades - High yield defaults These statistical results translate directly into useful portfolio construction techniques. For example, we show that the number of high-yield defaults in a portfolio can be reduced dramatically by excluding a very small number of names.