Using Merton Model: An Empirical Assessment of Alternatives

45 Pages Posted: 1 Apr 2012 Last revised: 15 Apr 2012

See all articles by Zvika Afik

Zvika Afik

Ben Gurion University

Ohad Arad

Ben-Gurion University of the Negev

Koresh Galil

Ben-Gurion University of the Negev - Department of Economics

Date Written: February 6, 2012

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.

Suggested Citation

Afik, Zvika and Arad, Ohad and Galil, Koresh, Using Merton Model: An Empirical Assessment of Alternatives (February 6, 2012). Available at SSRN: https://ssrn.com/abstract=2032678 or http://dx.doi.org/10.2139/ssrn.2032678

Zvika Afik

Ben Gurion University ( email )

Ohad Arad

Ben-Gurion University of the Negev ( email )

1 Ben-Gurion Blvd
Beer-Sheba 84105, 84105
Israel

Koresh Galil (Contact Author)

Ben-Gurion University of the Negev - Department of Economics ( email )

Beer-Sheva 84105
Israel
+972-8-6472310 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
297
rank
96,892
Abstract Views
1,293
PlumX Metrics