How to model default risk?

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Modelling default risk is a core task in fixed income and credit analysis. There are two broad approaches to modelling default risk. Structural Models (Firm Value Models) are based on the value of the firm’s assets relative to its debt. The key idea is that default occurs when the firm's asset value falls below a certain threshold. In contrast, Reduced-Form Models (Intensity-Based Models) treat default as a random event governed by a default intensity (hazard rate). They don’t model the firm’s asset value explicitly.

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