A Merton-Model Approach to Assessing the Default Risk of UK Public Companies
Bank of England Working Paper Series No. 194
38 Pages Posted: 15 Apr 2004
Date Written: June 2003
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.
Keywords: Merton models, corporate failure, implied default probabilities
JEL Classification: G12, G13
Suggested Citation: Suggested Citation
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