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Logit models: overcome weakness of the linear probability models using a transformation (logistic function) that restricts the probabilities to the zero-one interval.
Other alternatives include Probit and other variants with nonlinear indicator functions.
If we know the risk premium we can infer the probability of default. Expected return equals risk free rate after accounting for probability of default.
p (1+ k ) = 1+ i
May be generalized to loans with any maturity or to adjust for varying default recovery rates.
The loan can be assessed using the inferred probabilities from comparable quality bonds.
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