An Analysis of Option Pricing Model Prediction Power: Comparison with Z Score

This paper examines the prediction power between Z-score (Z) and Option pricing model (Distance to Default, DD) over 1990 to 2002 by US listed company data. In order to figure out the internet bubble effect, the firm-year observation values are divided by different time period and two types of companies. In intra-cohort analysis, we can not find strong evidence to support which model is
better. In power curve analysis, we discover that Option Pricing Model performs better than Z-score for all firms in the whole period, before and after the internet-bubble. For internet-related, electronic and telecommunication firms,Option Pricing Model still dominates in any period.