Hazard rate
The probability of default in a short period given that no default has happened before it. Times the probability of surviving to the start of a period, it gives that period's default probability.
Where you will meet it
Hazard rate appears in 5 learning outcomes on the CFA syllabus. A few of them:
- Explain expected exposure, probability of default, loss given default and the adjustment to value for credit (CVA)
“The probability of default for a period is the hazard rate multiplied by the probability of surviving to the start of that period, so it falls over time even with a constant hazard.”
- Explain the structural and the reduced-form approaches to modelling corporate credit risk, covering what each assumes and its strong and weak points
“Reduced-form models treat default as a random event arriving with a hazard rate that can depend on company and macro variables.”
- Work out a bond's value and credit spread from assumed credit risk parameters
“Build a table by date: for each, loss given default is the exposure times (1 − recovery), the probability of default is, in this discrete-period approximation, the hazard rate times the probability of surviving to the start of the period (with a continuous hazard it would be survival to the start times 1 minus exp(-hazard x period length)), and expected loss is their product, discounted at the risk-free rate.”
- Explain what a change in a credit spread indicates
“A useful approximation is spread ≈ annual probability of default (the hazard rate) × loss given default, before liquidity and risk premia.”
See also
Practise it
Practise hazard rate until it is automatic: questions that explain every wrong option.
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