Assessing Credit Quality from the Equity Market: Is Structural Approach a Better Approach?

摘要

We investigate the empirical performance of default probability prediction based on Merton’s (1974) structural credit risk model. More specifically, we study if Merton’s default measure, represented by distance-to-default, is a suf- ficient statistic to reflect the equity market information concerning the credit quality of the debt issuing firm. Employing the same information set, we show that a simple reduced form model outperforms Merton type of models for both in sample fitting and out of sample predictability for credit ratings. Both in-sample fitting and out-of-sample predictability can be greatly improved by including the firm’s equity value as an additional independent variable to the structural model. Moreover, the empirical performance of this hybrid model is very similar to that of the simple reduced form model. As a result, we conclude that although structural models are theoretically sound and distance-to-default is an important factor that determines the credit quality of the debt issuing firm, it does not adequately capture all the information from the equity market concerning the firm’s credit quality.