Exploring Variables that May Impair Merton Model in Predicting Defaults
Date Issued
2006
Date
2006
Author(s)
Li, Yan-Jeng
DOI
zh-TW
Abstract
In the Basel 2 environment, to measure credit risk more precisely may be a bank’s core competency. Among many methods of measuring credit risk, Merton model (option pricing) is the prevalent one. However, prior research documents Merton model’s weak predictability of corporate distress as compared with the competing models in Taiwan. In this thesis, we conjecture the major explanation is that stock price may fail to reflect the asset value of one company under certain circumstances. Moreover, the informativeness of the stock price varies among different company.
Based on the adjusted Merton model, we use both OLS and logit methods, aiming at identifying the variables underestimation of the expected default frequency or the outcome of type 1 error (default companies being categorized as non-default companies) from four aspects: information environment, stock price manipulation, stock valuation bubble, and the intensiveness of intangible asset. Our OLS analysis results show that companies subject to poor information environment, stock price bubble, and manipulation of stock price, are likely to be with Merton model underestimation of the expected default frequency. Consistently, our logit model tests reveal that observations subject to poor information environment, stock price bubble, manipulation of stock price, and high intensiveness of intangible asset, are more likely to be with the type 1 error.
We adopt the same method to identifying the variables contributing to overestimation of the expected default frequency or the type 2 error (non-default companies being categorized as default companies) from different aspects. Both OLS and logit analyses exhibit that when the market overreact to the financial ratios that primarily serve the stockholders, observations with poor information environment, especially those in the construction sector among these companies, are more likely to be subject to Merton model overestimation of the expected default frequency or the type 2 error.
Subjects
選擇權模型
KMV
信用風險
市場效率性
股價操縱
股價泡沫
無形資產
過度反應
Merton model
credit risk
market efficiency
stock price manipulation
stock price bubble
intangible asset
overreaction
Type
other
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