distance-to-default-calculation-and-trading-strategies

Python code for calculating the Merton model distance-to-default, including interactions with SQL server to extract the raw data. Distance-to-default is a measure of default risk. For a comprehensive discussion including calculation methodology and applications to equity markets refer to Vassalou and Xing (2004)¹².

The file db_interactions_for_DD.py uses pyodbc and pandas in functions that connect to a SQL Server database and extract the required data. This data includes balance sheet data, risk-free interest rates and market values.

The file distance_to_default.py calls the functions in script 1 and performs the necessary calculations for each stock in the cross-section, at yearly intervals from 2000 to 2012 (the extent of the data available to the author).

Footnotes

1. Vassalou, M. and Y. Xing (2004). "Default Risk in Equity Returns." The Journal of finance (New York) 59(2): 831-868. ↩

2. However, note that the conclusions of Vassalou and Xing (2004) regarding the pricing of default risk in equity markets are somewhat contrary to the majority of studies in this area. ↩