Bharath-Shumway Naive Distance-to-Default

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/** Deterministic D21-F01 Probability of Default reference calculations. */

type RecordValue = Record<string, unknown>;

function numberValue(name: string, value: unknown): number {
  if (typeof value !== "number" || !Number.isFinite(value)) throw new Error(`${name} must be a finite number`);
  return value;
}

function positive(name: string, value: unknown): number {
  const parsed = numberValue(name, value);
  if (parsed <= 0) throw new Error(`${name} must be positive`);
  return parsed;
}

function probability(name: string, value: unknown, openInterval = false): number {
  const parsed = numberValue(name, value);
  const valid = openInterval ? parsed > 0 && parsed < 1 : parsed >= 0 && parsed <= 1;
  if (!valid) throw new Error(`${name} must be ${openInterval ? "strictly " : ""}between zero and one`);
  return parsed;
}

function vector(name: string, value: unknown, minimum = 1): number[] {
  if (!Array.isArray(value) || value.length < minimum) throw new Error(`${name} must contain at least ${minimum} finite numbers`);
  return value.map((item, index) => numberValue(`${name}[${index}]`, item));
}

function clean(value: number): number {
  const rounded = Math.round((value + Number.EPSILON) * 1e12) / 1e12;
  return Object.is(rounded, -0) ? 0 : rounded;
}

function sigmoid(score: number): number {
  if (score >= 0) { const tail = Math.exp(-score); return 1 / (1 + tail); }
  const head = Math.exp(score); return head / (1 + head);
}

// Abramowitz-Stegun 7.1.26; adequate for the package's 1e-7 cross-language tolerance.
function erf(value: number): number {
  const sign = value < 0 ? -1 : 1;
  const x = Math.abs(value);
  const t = 1 / (1 + 0.3275911 * x);
  const polynomial = ((((1.061405429 * t - 1.453152027) * t + 1.421413741) * t - 0.284496736) * t + 0.254829592) * t;
  const y = 1 - polynomial * Math.exp(-x * x);
  return sign * y;
}

function normalCdf(value: number): number { return 0.5 * (1 + erf(value / Math.sqrt(2))); }

function linearScore(intercept: unknown, coefficients: unknown, features: unknown): [number, number[]] {
  const constant = numberValue("intercept", intercept);
  const beta = vector("coefficients", coefficients);
  const x = vector("features", features);
  if (beta.length !== x.length) throw new Error("coefficients and features must have equal length");
  const contributions = beta.map((item, index) => clean(item * x[index]));
  return [clean(constant + contributions.reduce((sum, item) => sum + item, 0)), contributions];
}

export function logisticPdModel(intercept: unknown, coefficients: unknown, features: unknown, alert_threshold: unknown): RecordValue {
  const [score, contributions] = linearScore(intercept, coefficients, features);
  const threshold = probability("alert_threshold", alert_threshold, true);
  const pd = sigmoid(score);
  return {
    linear_score: clean(score), feature_contributions: contributions,
    probability_of_default: clean(pd), survival_probability: clean(1 - pd),
    odds_of_default: clean(pd / (1 - pd)), alert_threshold: clean(threshold),
    state: pd >= threshold ? "at-or-above-alert" : "below-alert",
    reason: "supplied-logit-score-transformed",
  };
}

export function probitPdModel(intercept: unknown, coefficients: unknown, features: unknown, alert_threshold: unknown): RecordValue {
  const [score, contributions] = linearScore(intercept, coefficients, features);
  const threshold = probability("alert_threshold", alert_threshold, true);
  const pd = normalCdf(score);
  return {
    latent_score: clean(score), feature_contributions: contributions,
    probability_of_default: clean(pd), survival_probability: clean(1 - pd),
    alert_threshold: clean(threshold), state: pd >= threshold ? "at-or-above-alert" : "below-alert",
    reason: "supplied-probit-score-transformed",
  };
}

export function throughTheCyclePd(annual_obligors: unknown, annual_defaults: unknown, current_year_index: unknown, minimum_years: unknown): RecordValue {
  const obligors = vector("annual_obligors", annual_obligors, 2);
  const defaults = vector("annual_defaults", annual_defaults, 2);
  if (obligors.length !== defaults.length) throw new Error("annual_obligors and annual_defaults must have equal length");
  const minimum = positive("minimum_years", minimum_years);
  if (!Number.isInteger(minimum) || obligors.length < minimum) throw new Error("minimum_years must be an integer no greater than the history length");
  const index = numberValue("current_year_index", current_year_index);
  if (!Number.isInteger(index) || index < 0 || index >= obligors.length) throw new Error("current_year_index must select an observed year");
  const rates = obligors.map((population, year) => {
    const count = defaults[year];
    if (population <= 0) throw new Error(`annual_obligors[${year}] must be positive`);
    if (!Number.isInteger(count) || count < 0 || count > population) throw new Error(`annual_defaults[${year}] must be an integer from zero to obligors`);
    return count / population;
  });
  const ttc = rates.reduce((sum, item) => sum + item, 0) / rates.length;
  const pooled = defaults.reduce((sum, item) => sum + item, 0) / obligors.reduce((sum, item) => sum + item, 0);
  const current = rates[index];
  return {
    annual_default_rates: rates.map(clean), through_the_cycle_pd: clean(ttc), pooled_default_rate: clean(pooled),
    current_observed_default_rate: clean(current), cycle_gap: clean(current - ttc), observation_years: rates.length,
    state: current > ttc ? "current-above-long-run" : current < ttc ? "current-below-long-run" : "current-equals-long-run",
    reason: "simple-average-of-annual-one-year-rates",
  };
}

export function pointInTimePd(through_the_cycle_pd_value: unknown, borrower_log_odds_shift: unknown, macro_factor_z: unknown, macro_sensitivity: unknown, alert_threshold: unknown): RecordValue {
  const ttc = probability("through_the_cycle_pd", through_the_cycle_pd_value, true);
  const borrowerShift = numberValue("borrower_log_odds_shift", borrower_log_odds_shift);
  const macro = numberValue("macro_factor_z", macro_factor_z);
  const sensitivity = numberValue("macro_sensitivity", macro_sensitivity);
  if (sensitivity < 0) throw new Error("macro_sensitivity must be nonnegative under this package convention");
  const threshold = probability("alert_threshold", alert_threshold, true);
  const baselineLogOdds = Math.log(ttc / (1 - ttc));
  const macroShift = sensitivity * macro;
  const pd = sigmoid(baselineLogOdds + borrowerShift + macroShift);
  return {
    through_the_cycle_pd: clean(ttc), baseline_log_odds: clean(baselineLogOdds), borrower_log_odds_shift: clean(borrowerShift),
    macro_log_odds_shift: clean(macroShift), point_in_time_pd: clean(pd), cycle_uplift: clean(pd - ttc),
    alert_threshold: clean(threshold), state: pd >= threshold ? "at-or-above-alert" : "below-alert",
    reason: "declared-log-odds-overlay-not-universal-ifrs-or-regulatory-formula",
  };
}

function mertonTerms(asset: number, sigma: number, debt: number, rate: number, horizon: number): [number, number] {
  const scale = sigma * Math.sqrt(horizon);
  const d1 = (Math.log(asset / debt) + (rate + 0.5 * sigma * sigma) * horizon) / scale;
  return [d1, d1 - scale];
}

export function mertonDistanceToDefault(equity_value: unknown, equity_volatility: unknown, debt_face_value: unknown, risk_free_rate: unknown, asset_drift: unknown, horizon_years: unknown, tolerance: unknown, max_iterations: unknown): RecordValue {
  const equity = positive("equity_value", equity_value), sigmaEquity = positive("equity_volatility", equity_volatility);
  const debt = positive("debt_face_value", debt_face_value), rate = numberValue("risk_free_rate", risk_free_rate);
  const drift = numberValue("asset_drift", asset_drift), horizon = positive("horizon_years", horizon_years);
  const tol = positive("tolerance", tolerance), limit = positive("max_iterations", max_iterations);
  if (!Number.isInteger(limit) || limit > 10000) throw new Error("max_iterations must be an integer no greater than 10000");
  let asset = equity + debt * Math.exp(-rate * horizon), sigmaAsset = Math.min(3, Math.max(1e-6, sigmaEquity * equity / asset));
  let residual = Number.POSITIVE_INFINITY, converged = false, iterations = 0;
  for (iterations = 1; iterations <= limit; iterations += 1) {
    const [d1, d2] = mertonTerms(asset, sigmaAsset, debt, rate, horizon), n1 = normalCdf(d1), n2 = normalCdf(d2);
    if (n1 <= 1e-14) break;
    const nextAsset = (equity + debt * Math.exp(-rate * horizon) * n2) / n1;
    const nextSigma = sigmaEquity * equity / (nextAsset * n1);
    residual = Math.max(Math.abs(nextAsset - asset) / Math.max(asset, 1), Math.abs(nextSigma - sigmaAsset));
    asset = nextAsset; sigmaAsset = nextSigma;
    if (residual <= tol) { converged = true; break; }
  }
  if (!converged) return { asset_value: null, asset_volatility: null, distance_to_default: null, physical_default_probability: null, risk_neutral_default_probability: null, iterations: Math.min(iterations, limit), residual: Number.isFinite(residual) ? clean(residual) : null, state: "not-converged", reason: "merton-equity-system-did-not-converge" };
  const [, d2] = mertonTerms(asset, sigmaAsset, debt, rate, horizon);
  const dd = (Math.log(asset / debt) + (drift - 0.5 * sigmaAsset * sigmaAsset) * horizon) / (sigmaAsset * Math.sqrt(horizon));
  return { asset_value: clean(asset), asset_volatility: clean(sigmaAsset), distance_to_default: clean(dd), physical_default_probability: clean(normalCdf(-dd)), risk_neutral_default_probability: clean(normalCdf(-d2)), iterations, residual: clean(residual), state: "converged", reason: "merton-equity-system-solved" };
}

export function chsDistressProbability(nimtaavg: unknown, tlmta: unknown, exretavg: unknown, sigma: unknown, rsize: unknown, cashmta: unknown, market_to_book: unknown, log_price: unknown): RecordValue {
  const values: Record<string, number> = { nimtaavg: numberValue("nimtaavg", nimtaavg), tlmta: numberValue("tlmta", tlmta), exretavg: numberValue("exretavg", exretavg), sigma: numberValue("sigma", sigma), rsize: numberValue("rsize", rsize), cashmta: numberValue("cashmta", cashmta), market_to_book: numberValue("market_to_book", market_to_book), log_price: numberValue("log_price", log_price) };
  if (values.sigma < 0 || values.tlmta < 0 || values.cashmta < 0) throw new Error("sigma, tlmta, and cashmta must be nonnegative");
  const beta: Record<string, number> = { nimtaavg: -20.264, tlmta: 1.416, exretavg: -7.129, sigma: 1.411, rsize: -0.045, cashmta: -2.132, market_to_book: 0.075, log_price: -0.058 };
  const contributions: Record<string, number> = {};
  Object.keys(values).forEach(key => { contributions[key] = clean(values[key] * beta[key]); });
  const score = -9.164 + Object.values(contributions).reduce((sum, item) => sum + item, 0);
  return { published_intercept: -9.164, score_contributions: contributions, failure_log_odds: clean(score), distress_probability: clean(sigmoid(score)), state: "published-score-replication", reason: "chs-table-4-twelve-month-lag-coefficients" };
}

export function bharathShumwayNaiveDistanceToDefault(equity_value: unknown, debt_face_value: unknown, equity_volatility: unknown, prior_year_equity_return: unknown, horizon_years: unknown): RecordValue {
  const equity = positive("equity_value", equity_value), debt = positive("debt_face_value", debt_face_value);
  const sigmaEquity = positive("equity_volatility", equity_volatility), drift = numberValue("prior_year_equity_return", prior_year_equity_return), horizon = positive("horizon_years", horizon_years);
  const firm = equity + debt, sigmaDebt = 0.05 + 0.25 * sigmaEquity;
  const sigmaAsset = (equity / firm) * sigmaEquity + (debt / firm) * sigmaDebt;
  const dd = (Math.log(firm / debt) + (drift - 0.5 * sigmaAsset * sigmaAsset) * horizon) / (sigmaAsset * Math.sqrt(horizon));
  return { naive_firm_value: clean(firm), naive_debt_volatility: clean(sigmaDebt), naive_asset_volatility: clean(sigmaAsset), naive_distance_to_default: clean(dd), naive_default_probability: clean(normalCdf(-dd)), state: "calculated", reason: "bharath-shumway-naive-approximation" };
}

export function calculate(topicId: string, inputs: RecordValue): RecordValue {
  if (!inputs || typeof inputs !== "object" || Array.isArray(inputs)) throw new Error("inputs must be an object");
  switch (topicId) {
    case "D21-F01-A01": return logisticPdModel(inputs.intercept, inputs.coefficients, inputs.features, inputs.alert_threshold);
    case "D21-F01-A02": return probitPdModel(inputs.intercept, inputs.coefficients, inputs.features, inputs.alert_threshold);
    case "D21-F01-A03": return throughTheCyclePd(inputs.annual_obligors, inputs.annual_defaults, inputs.current_year_index, inputs.minimum_years);
    case "D21-F01-A04": return pointInTimePd(inputs.through_the_cycle_pd_value, inputs.borrower_log_odds_shift, inputs.macro_factor_z, inputs.macro_sensitivity, inputs.alert_threshold);
    case "D21-F01-A05": return mertonDistanceToDefault(inputs.equity_value, inputs.equity_volatility, inputs.debt_face_value, inputs.risk_free_rate, inputs.asset_drift, inputs.horizon_years, inputs.tolerance, inputs.max_iterations);
    case "D21-F01-A06": return chsDistressProbability(inputs.nimtaavg, inputs.tlmta, inputs.exretavg, inputs.sigma, inputs.rsize, inputs.cashmta, inputs.market_to_book, inputs.log_price);
    case "D21-F01-A07": return bharathShumwayNaiveDistanceToDefault(inputs.equity_value, inputs.debt_face_value, inputs.equity_volatility, inputs.prior_year_equity_return, inputs.horizon_years);
    default: throw new Error(`unsupported topic_id: ${topicId}`);
  }
}