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Using Option Theory and Fundamentals to Assessing Default Risk of Listed Firms

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  • Papanastasopoulos, George
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    Abstract

    In this paper, we use option based measures of financial performance that utilize market information in a binary probit regression to examine their informational context and properties as distress indicators and to estimate default probabilities for listed firms. Then, we enrich them with fundamentals that utilize accounting information. The results suggest that by adding accounting information from financial statements to market information from equity prices we can improve both in sample fitting and out of sample predictability of defaults. Therefore, option theory does not generate sufficient statistics of the actual default frequency. Our main conclusion is that while market information can be extremely valuable, it is most useful when coupled with accounting information in assessing default risk of listed firms.

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    File URL: http://mpra.ub.uni-muenchen.de/453/
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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 453.

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    Date of creation: Oct 2005
    Date of revision: Jun 2006
    Handle: RePEc:pra:mprapa:453

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    Keywords: option theory; fundamentals; default risk;

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    1. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 50(1), pages 53-85, March.
    2. Franks, Julian R. & Torous, Walter N., 1994. "A comparison of financial recontracting in distressed exchanges and chapter 11 reorganizations," Journal of Financial Economics, Elsevier, Elsevier, vol. 35(3), pages 349-370, June.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    4. Saikat Nandi, 1998. "Valuation models for default-risky securities: An overview," Economic Review, Federal Reserve Bank of Atlanta, Federal Reserve Bank of Atlanta, issue Q 4, pages 22-35.
    5. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 59(2), pages 831-868, 04.
    6. Alexandros Benos & George Papanastasopoulos, 2005. "Extending the Merton Model: A Hybrid Approach to Assessing Credit Quality," Finance, EconWPA 0505020, EconWPA, revised 03 Jun 2005.
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