Using Merton model for default prediction: An empirical assessment of selected alternatives

Zvika Afik, Ohad Arad and Koresh Galil ()

Journal of Empirical Finance, 2016, vol. 35, issue C, 43-67

Abstract: It is surprising that although four decades passed since the publication of Merton (1974) model, and despite the development and publications of various extensions and alternative models, the original model is still used extensively by practitioners, and even academics, to assess credit risk. We empirically examine specification alternatives for Merton model and a selection of its variants, concluding that default prediction goodness is mainly sensitive to the choice of assets expected return and volatility. A Down-and–Out Option pricing model and a simple naïve model outperform the most common variants of the Merton model, therefore we recommend using the simple model for its easy implementation.

Keywords: Credit risk; Default prediction; Merton model; Bankruptcy prediction; Default threshold; Assets volatility (search for similar items in EconPapers)
JEL-codes: G13 G17 G33 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:35:y:2016:i:c:p:43-67

DOI: 10.1016/j.jempfin.2015.09.004

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