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A Merton-model approach to assessing the default risk of UK public companies

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  • Merxe Tudela
  • Garry Young

Abstract

In this paper it is shown 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. Power curves and accuracy ratios are also examined. It is shown that there is much useful information in the Merton-style estimates.

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File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2003/wp194.pdf
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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 194.

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Date of creation: Jun 2003
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Handle: RePEc:boe:boeewp:194

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  1. Geroski,Paul A. & Gregg,Paul, 1997. "Coping with Recession," Cambridge Books, Cambridge University Press, number 9780521626019, October.
  2. Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
  3. 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.
  4. 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.
  5. Saikat Nandi, 1998. "Valuation models for default-risky securities: An overview," Economic Review, Federal Reserve Bank of Atlanta, issue Q 4, pages 22-35.
  6. 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.
  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. McFadden, Daniel, 1974. "The measurement of urban travel demand," Journal of Public Economics, Elsevier, vol. 3(4), pages 303-328, November.
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