### Resumé

Sprog | Engelsk |
---|---|

Tidsskrift | Journal of Banking & Finance |

Vol/bind | 50 |

Sider | 493–505 |

ISSN | 0378-4266 |

DOI | |

Status | Udgivet - jan. 2015 |

### Emneord

- Default risk
- Distance-to-default
- Merton’s model
- Stochastic volatility
- Jump-diffusion

### Citer dette

*Journal of Banking & Finance*,

*50*, 493–505. DOI: 10.1016/j.jbankfin.2014.05.016

}

*Journal of Banking & Finance*, bind 50, s. 493–505. DOI: 10.1016/j.jbankfin.2014.05.016

**Robustness of Distance-to-Default.** / Jessen, Cathrine; Lando, David.

Publikation: Bidrag til tidsskrift › Tidsskriftartikel › Forskning › peer review

TY - JOUR

T1 - Robustness of Distance-to-Default

AU - Jessen,Cathrine

AU - Lando,David

PY - 2015/1

Y1 - 2015/1

N2 - Distance-to-default (DD) is a measure of default risk derived from observed stock prices and book leverage using the structural credit risk model of Merton (1974). Despite the simplifying assumptions that underlie its derivation, DD has proven empirically to be a strong predictor of default. We use simulations to show that the empirical success of DD may well be a result of its strong robustness to model misspecifications. We consider a number of deviations from the Merton model which involve different asset value dynamics and different default triggering mechanisms. We show that, in general, DD is successful in ranking firms’ default probabilities, even if the underlying model assumptions are altered. A possibility of large jumps in asset value or stochastic volatility challenge the robustness of DD. We propose a volatility adjustment of the distance-to-default measure that significantly improves the ranking of firms with stochastic volatility, but this measure is less robust to model misspecifications than DD.

AB - Distance-to-default (DD) is a measure of default risk derived from observed stock prices and book leverage using the structural credit risk model of Merton (1974). Despite the simplifying assumptions that underlie its derivation, DD has proven empirically to be a strong predictor of default. We use simulations to show that the empirical success of DD may well be a result of its strong robustness to model misspecifications. We consider a number of deviations from the Merton model which involve different asset value dynamics and different default triggering mechanisms. We show that, in general, DD is successful in ranking firms’ default probabilities, even if the underlying model assumptions are altered. A possibility of large jumps in asset value or stochastic volatility challenge the robustness of DD. We propose a volatility adjustment of the distance-to-default measure that significantly improves the ranking of firms with stochastic volatility, but this measure is less robust to model misspecifications than DD.

KW - Default risk

KW - Distance-to-default

KW - Merton’s model

KW - Stochastic volatility

KW - Jump-diffusion

U2 - 10.1016/j.jbankfin.2014.05.016

DO - 10.1016/j.jbankfin.2014.05.016

M3 - Journal article

VL - 50

SP - 493

EP - 505

JO - Journal of Banking & Finance

T2 - Journal of Banking & Finance

JF - Journal of Banking & Finance

SN - 0378-4266

ER -