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

See all articles by Merxe Tudela

Merxe Tudela

Bank of England - Market Infrastructure Division

Garry Young

ESCOE

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

Tudela, Merxe and Young, Garry, A Merton-Model Approach to Assessing the Default Risk of UK Public Companies (June 2003). Bank of England Working Paper Series No. 194, Available at SSRN: https://ssrn.com/abstract=530642 or http://dx.doi.org/10.2139/ssrn.530642

Merxe Tudela (Contact Author)

Bank of England - Market Infrastructure Division ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom
+44 (0)207 601 3840 (Phone)

HOME PAGE: www.bankofengland.co.uk

Garry Young

ESCOE ( email )

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