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Default Probability Prediction with Static Merton-D-Vine Copula Model

Author

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  • Václav Klepáč

    (Mendel University in Brno, Czech Republic)

Abstract

We apply standard Merton and enhanced Merton-D-Vine copula model for the measurement of credit risk on the basis of accounting and stock market data for 4 companies from Prague Stock Exchange, in the midterm horizon of 4 years. Basic Merton structural credit model is based on assumption that firm equity is European option on company assets. Consequently enhanced Merton model take in account market data, dependence between daily returns and its volatility and helps to evaluate and project the credit quality of selected companies, i.e. correlation between assets trajectories through copulas. From our and previous results it is obvious that basic Merton model significantly underestimates actual level, i.e. offers low probabilities of default. Enhanced model support us with higher simulated probability rates which mean that capturing of market risk and transferring it to credit risk estimates is probably a good way or basic step in enhancing Merton methodology.

Suggested Citation

  • Václav Klepáč, 2015. "Default Probability Prediction with Static Merton-D-Vine Copula Model," European Journal of Business Science and Technology, Mendel University in Brno, Faculty of Business and Economics, vol. 1(2), pages 104-113.
    • Handle: RePEc:men:journl:v:1:y:2015:i:2:p:104-113
    DOI: 10.11118/ejobsat.v1i2.30
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Merton model; default risk; d-vine copula; probability; ARMA-GARCH;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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