8/13/2019 Could We Apply Structural

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Could we apply structural Merton model to private firms, despite we dont have market values?

Merton's model has benefited from better data on asset volatility relative to cash flow volatility (there are usually

only a handful of relevant cash flow observations, which makes volatility estimation difficult). For private firms,however, market value information is not available by definition. One solution is to infer what we think these

values would be, based on industry, size and other financial variables. n practice, a Merton model applied to

private firms looks very much like a nonstructural model that was formed usin! va!ue intuition from the Mertonmodel. " #$%& FO# #*++ OM&-+$ p./0"

What target company we address our model to?

$mall and Medium +nterprises ($M+s) constitute a si!nificant part of many western economies, see &cs and&udretsch (/001), O+2 $M+s Outlook (3443) and 5dell (3446). $M+s are defined within the +5 as

enterprises that are valued at less than 74 Million +uros (O+2 $M+s Outlook 34438 99$ 34478 99$ 344:89eresford and $aunders 3447). The two approaches to assessment of default within companies is the Accounting

based approach and the Merton based approach.

Predictive power of the models

& number of papers in the literature have recently critically assessed the Merton type models, e;aminin! themodelor accountin!=based and market=based models becomes a !reatchallen!e in credit risk measurement. & recent empirical studies, such as %ealhofer, %wok and ?en! (/00@),

2elianedis and Aeske (/000), 2elianedis and Aeske (344/), eland (3443), and *assalou and Bin! (344/)document that the theoretical probability measures estimated from structural default risk models have !ood

predictive power over credit ratin!s and ratin! transitions. "redit #isk Modellin! thesis p.341"

Data needed for M!"Merton type models

+stimated asset value and volatilityC in this step the asset value and asset volatility of the firm is estimated fromthe market value and volatility of eDuity and the book value of liabilities.

#ook vs$ Market value of assets

$ince a firm's asset value could si!nificantly chan!e with a ma>or investment and financin! action, it makes

more sense to standardize the firm's market value of assets by its book value so that the pure scalin! effect willnot distort the parameter values in the time series estimation. " a forward intensity approach p.3E