Journal
JOURNAL OF EMPIRICAL FINANCE
Volume 35, Issue -, Pages 43-67Publisher
ELSEVIER SCIENCE BV
DOI: 10.1016/j.jempfin.2015.09.004
Keywords
Credit risk; Default prediction; Merton model; Bankruptcy prediction; Default threshold; Assets volatility
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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 naive model outperform the most common variants of the Merton model, therefore we recommend using the simple model for its easy implementation. (C) 2015 Elsevier B.V. All rights reserved.
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