Glossary term
Distance to Default
A measure of how far a company’s asset value is from the point at which it could not repay its debt, expressed in standard deviations, derived from its equity price, equity volatility and debt structure (the Merton model). It turns stock-market information into a credit signal that updates daily.
AI-generated — produced automatically by Closelook’s systems under this site’s editorial policy.
What it means
The Merton model treats a company’s equity as a call option on its assets with a strike at the value of its debt: shareholders own whatever is left after lenders are paid. From the market value and volatility of the equity and the face value and maturity of the debt, the model backs out the implied value and volatility of the assets and asks how many standard deviations the assets are above the default point. A distance of 6 is very safe; below 2 is watched; near 0 the market prices default as likely.
Its advantage over ratings and spreads is speed: equity trades every second, and a falling stock with rising volatility lowers the distance before any bond reprices.
Why it matters for the AI trade
The instrument that would answer the AI credit question directly — single-name credit default swaps on Oracle, CoreWeave or Nebius — is institutional data no retail-accessible vendor carries. Distance to default can be built from data Closelook already holds: daily prices, realised volatility and the debt structure from filings. It also captures the trigger the credit stress tape most wants to see — a company whose shares rise while its default probability rises, because leverage is doing the lifting.
How Closelook uses it
It is the planned second phase of the credit stress tape, alongside traded bond prices; the current tape works from filings ratios and bellwether bond yields with the AI residual as its issuer-specific term. The Altman Z-score entry covers the older, accounting-based cousin.
Common questions
- What inputs does distance to default need?
- The market value of equity, the volatility of equity, the face value and maturity of debt, and the risk-free rate. All are public; the model solves for asset value and asset volatility.
- How does it compare with a credit rating?
- A rating is a committee’s judgement updated a few times a year; distance to default is a market-implied number updated daily. Studies since the 1990s find it leads rating changes by months.
- Why is it useful for AI builders specifically?
- Because their debt is young, their assets depreciate fast and their equity is volatile — exactly the conditions under which a market-based measure moves first and a filings-based one moves last.