In this thread, I hope we can examine some information/explore hypotheses regarding value investing as applied to bonds. To get things started, I found this pdf which appears to be a presentation given by Altman (if you know the original source of this information, let me know… I still haven't read any of Altman's papers yet.)
The Use of Credit Scoring Models and the Importance of a Credit Culture
There seems to be a lot of interesting information in the presentation (which I've only given a good skim) but I would like to point out, in particular, page 9. It gives the mean and SD Z-Score for each bond rating. There's a pretty solid relationship. The question I have is whether or not Z-Score adds something new to the credit score. This leads me to propose the following hypothesis for consideration.
Suppose I look at a particular investment class of bonds (say BB rated). Each firm in the BB rated class will have a Z-score and there is a distribution of Z-scores. Suppose I select only those firms which have high Z-score (say above 3). Will the default rates be lower than the whole class of BB scores? Secondly, will bond prices/interest rates already have accounted for this fact? (to wit, is market efficiency not going to allow me to profit from this difference?)
Stated differently, can I improve bond returns by selecting high risk/high reward bonds (meaning low credit rating) that have high Altman Z-score (low risk)?
If anyone has insight or knows of such research I'd be interested.
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