The predictive performance of a path-dependent exotic-option credit risk model in the emerging market

Dar-Hsin Chen, Heng-Chih Chou, David Wang and Rim Zaabar

Physica A: Statistical Mechanics and its Applications, 2011, vol. 390, issue 11, 1973-1981

Abstract: Most empirical research of the path-dependent, exotic-option credit risk model focuses on developed markets. Taking Taiwan as an example, this study investigates the bankruptcy prediction performance of the path-dependent, barrier option model in the emerging market. We adopt Duan’s (1994) [11], (2000) [12] transformed-data maximum likelihood estimation (MLE) method to directly estimate the unobserved model parameters, and compare the predictive ability of the barrier option model to the commonly adopted credit risk model, Merton’s model. Our empirical findings show that the barrier option model is more powerful than Merton’s model in predicting bankruptcy in the emerging market. Moreover, we find that the barrier option model predicts bankruptcy much better for highly-leveraged firms. Finally, our findings indicate that the prediction accuracy of the credit risk model can be improved by higher asset liquidity and greater financial transparency.

Keywords: Credit risk; Bankruptcy prediction; Merton’s model; Barrier option model; Transformed-data MLE method (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:390:y:2011:i:11:p:1973-1981

DOI: 10.1016/j.physa.2010.10.030

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