Default risk is a risk that firms have to bear whenever they failed to meet their debt obligation as the debt matured. Providing an assessment to predict default risk is one of the ways to mitigate the risk. However, default risk tends to be overestimated or underestimated if the asset values are not calculated accurately. This can be the reason to the public misconception towards the financial position of the firm. Accordingly, this paper presents the structured way of calculating the iterated market value of asset and its volatility of a firm based on Merton’s approach. The iterated market value of asset and its volatility are used to predict default risk of a firm using Merton-KMV model. The iteration procedure is done until the values are found converged up to 10−3. A sample of data of PN17 Company is used to run the procedures. As a result, we found that the market value of assets and its volatility mostly reached their convergence at the third iterations with the value of volatility of 114.30%. Meanwhile, the probability of default of the PN17 Company is found to be converged at the second iteration with the value of 0.0276%. In this case, low default risk is predicted.

1.
P.J.
Crosbie
and
J.R.
Bohn
,
Modeling default risk: Modeling methodology
(
Moody’s KMV Workingpaper
,
2003
).
2.
M.
Tudela
and
G.
Young
,
Int. J. Theoretical Appl. Finance
,
8
(
06
),
737
761
(
2005
).
3.
A.
Breccia
,
Formal Bankruptcy: Strategic Debt Service with Senior and Junior Creditors
(
Economics working papers series
,
Birkbeck
, University of London, August
2004
).
4.
A.
Beber
,
R.
Corvino
and
G.
Fusa
,
Default risk premium in credit and equity market: A new approach for structural model estimation
(
2015
). Available at SSRN 2611984.
5.
S. T.
Bharath
and
T.
Shumway
,
Rev. Finan. Stud.
,
21
(
3
),
1339
1369
(
2008
). doi:
6.
M.
Vassalou
and
Y.
Xing
,
J. Finance
,
59
(
2
),
831
868
(
2004
). doi:
7.
E. I.
Ronn
and
A. K.
Verma
,.
J. Finance
,
41
(
4
),
871
896
(
1986
).
8.
I. J.
Kim
,
S. J.
Byun
,
S. Y.
Hwang
, “
An iteration method for implementing Merton model, Korean Financial Societies 2013
,” in
Five Academic Societies Joint Academic Research Presentations
, p.
1805
1820
.
9.
R.C.
Merton
,
J. Finance
,
29
(
2
),
449
470
(
1974
).
10.
X.
Liang
, “
An empirical estimation of the default risk of Chinese listed company based on the Merton-KMV Model
,”
Norwegian School of Economics
,
2012
.
This content is only available via PDF.
You do not currently have access to this content.