• Modeling Corporate Credit Risk with Multiple Debt Issues

Abstract

Due to the improperly simplified assumptions of the traditional BSM (Black-Scholes-Merton) model, the prediction of performance in detective default is not very accurate. The application of compound option theory to establish the credit risk model of detective default in firms is more fit to the debt structure for firms in real world. From the empirical study results, both the CO model and the BSM model have good ability to detect the default of firms, but compared with the traditional BSM structural model using market information, the result of mpirical testing shows the performance of detective default in firms of our CO model established by the using of compound option theory has improved effect. Furthermore, using the censored Tobit regression model to observe the characteristics of detective default performance in two structural models, we also find the traditional BSM model that only considers the solvency factors and the market factors in firms, compared with the CO model that considers the profitability factor in firms also, the latter model might detect default in firms more effectively for our reasonable inference. Besides the BSM model with arket-based framework, the CO model can be used as another good tool in the detection of firms’ default.

Keywords: Credit risk model, BSM model, Compound option model, Tobit regression