Default Model

Quantitative analysis and number crunching has become a huge business on Wall Street, and freshly graduating quant specialists can often find well paying jobs awaiting them at trading houses, banks, and hedge funds. This is due to the increased data analysis demands for risk management and opportunity mining that requires summarizing into digestible terms for traders to set their parameters.

While technical analysis is crucial for timing on forex, stocks, futures, and options trading, it is also essential for determining the risk of non payment for bonds.

The default model is relied upon extensively by ratings agencies, such as Moody’s and S&P to gauge the likelihood of a company not being able to make good on its debt obligations. The default model calculates a company’s income, expenses, other debt, and all of the other contingencies in order to create a financial model of that company for rating purposes. The letter ratings are indicative of perceived risk, with AAA or Aaa being the lowest and BBB- or Baa2 being the highest risk, while still being considered investment grade. This is before entering junk bond status (CCC or Caa) or lower.

Maybe if the ratings agencies paid more attention to the underlying risk on subprime mortgages, their default models would have been accurate enough to avoid crashing the banking system.