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A Merton-Model Approach To Assessing The Default Risk Of Uk Public Companies

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  • M. TUDELA

    ()
    (Bank of England, Threadneedle Street, London, EC2R 8AH, UK)

  • G. YOUNG

    ()
    (Bank of England, Threadneedle Street, London, EC2R 8AH, UK)

Abstract

This paper shows how a Merton-model approach can be used to develop measures of the probability of failure of individual quoted UK companies. Probability estimates are then constructed for a group of failed companies and their properties as leading indicators of failure assessed. Probability estimates of failure for a control group of surviving companies are also constructed. These are used in probit regressions to evaluate the information content of the Merton-based estimates relative to information available in company accounts and in assessing Type I and Type II errors. We also look at power curves and accuracy ratios. The paper shows that there is much useful information in the Merton-style estimates.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

Volume (Year): 08 (2005)
Issue (Month): 06 ()
Pages: 737-761

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Handle: RePEc:wsi:ijtafx:v:08:y:2005:i:06:p:737-761

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Related research

Keywords: Merton models; corporate failure; default probabilities;

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  1. McFadden, Daniel, 1974. "The measurement of urban travel demand," Journal of Public Economics, Elsevier, vol. 3(4), pages 303-328, November.
  2. Saikat Nandi, 1998. "Valuation models for default-risky securities: An overview," Economic Review, Federal Reserve Bank of Atlanta, issue Q 4, pages 22-35.
  3. John G. Cragg & Russell S. Uhler, 1970. "The Demand for Automobiles," Canadian Journal of Economics, Canadian Economics Association, vol. 3(3), pages 386-406, August.
  4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  5. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
  6. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
  7. Briys, Eric & de Varenne, Fran├žois, 1997. "Valuing Risky Fixed Rate Debt: An Extension," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(02), pages 239-248, June.
  8. Geroski,Paul A. & Gregg,Paul, 1997. "Coping with Recession," Cambridge Books, Cambridge University Press, number 9780521622769, December.
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