In a new report, Marty Fridson – chief investment officer for Lehmann Livian Fridson Advisors LLC, a wealth management firm specializing in income investing – discussed an alternate formula for estimating market-implied 12-month high-yield default rate. Fridson explained why he believes his formula provides a more accurate default rate estimate than the traditional formula break-even analysis formula.

The Break-Even Approach

The standard break-even formula, which could theoretically be used to calculate default rate is this one:

Speculative-grade (SG) yield = Treasury yield + Market-implied default rate – Recovery rate

However, Fridson pointed out that solving this equation for market-implied default rate almost always produces a rate that indicates that the high-yield market is undervalued. “In short, it is useless,” he declared.

Fridson’s Solution

Fridson’s method of estimating market-implied default rate involves…

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