Structural Credit Risk Modelling and Valuation Based on the Merton Model

Abstract

The main aim of this research is to model and analyze the probability of default of corporate entities on their bonds using the Merton Model and subsequently evaluate each of the entity’s credit spread. Financial companies have a risk of becoming insolvent due to poor credit risk assessment and management. Bankruptcy is a major issue in the nancial sector as it leads to a decrease in economic growth rate. The structural credit risk model used has been e ective in the determination of the probability of default. The Merton Model uses a company’s capital structure and its asset volatility to analyze the default probability at a given maturity time. The data analysis shows that default probabilities are directly proportional to the company’s liabilities, whereas the credit spread is directly proportional to the risk of default but inversely proportional to the credit quality of that particular company. This research is a comprehensive guide to the assessment, analysis and management of credit risk.