The term default risk refers to the possibility of a sustained financial loss as a result of an investment.
- With bonds and liquidity it implies that the borrower is unable to meet the requirements and the invested money is not or only incompletely paid back.
- With stocks it means that because of entrepreneurial failure the company value – and with it also the share price – permanently declines.
- With real estate the default risk is reflected in a permanent devaluation of property values.
- With commodities it is expressed in a lasting decline in price.
The default risk is one of the main risks for long-term investors. It is measured by default probability. However, it is very difficult to compute mathematically. As the duration of an investment increases, it is more and more difficult to estimate. To obtain an approximate value, risk factors are generally collected and weighted according to empirical values.