Using Merton model: an empirical assessment of alternatives

Zvika Afik (), Ohad Arad () and Koresh Galil ()
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Zvika Afik: Guilford Glazer faculty of Business and Management, Ben- Gurion University of the Negev, Israel
Ohad Arad: Ben Gurion University of the Negev, Beer-Sheva, Israel

No 1202, Working Papers from Ben-Gurion University of the Negev, Department of Economics

Abstract: Merton (1974) suggested a structural model for default prediction which allows using timely information from the equity market. The literature describes several specifications to the application of the model, including methods presumably used by practitioners. However, recent studies demonstrate that these methods result in inferior estimates compared to simpler substitutes. We empirically examine various specification alternatives and find that the prediction goodness is only slightly sensitive to different choices of default barrier, whereas the choice of assets expected return and assets volatility is significant. Equity historical return and historical volatility produce underbiased estimates for assets expected return and assets volatility, especially for defaulting firms. Acknowledging these characteristics we suggest specifications that improve the model accuracy.

Keywords: Credit risk; Default prediction; Merton model; Bankruptcy prediction, Default barrier; Assets volatility (search for similar items in EconPapers)
JEL-codes: G13 G17 G33 (search for similar items in EconPapers)
Pages: 46
Date: 2012
New Economics Papers: this item is included in nep-ban, nep-for and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Working Paper: Using Merton model: an empirical assessment of alternatives (2015)
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