ASSESSING THE MODIFIED MERTON DISTANCE TO THE DEFAULT MODEL WITH CDS PRICE

This paper provides a way that a Merton-model approach can be modified to develop measures of the probability of default of companies indexed in Standard & Poor’s 500 Index (S&P 500) after a financial crisis. It also examines the accuracy and contribution of the modified Merton Distance to default model based on Merton’s (1974) bond pricing model. Credit Default Swap (CDS) spreads as a plausible indicator of default risk are used in the assessment. The tests are implemented by modeling results’ correlation with data obtained from 2008 to 2017. The sample is based on 112 firms indexed in S&P 500 and is selected according to the availability of outstanding CDS contracts between the test periods.It is found that the results generated by the modified Merton-style approach is consistent with the spreads of credit default swaps. Then it can be concluded that although the modified KMV Merton model fails to generate a sufficient result for the probability of default, it still can be used as a reference for default estimate.