Robustness of Distance-to-Default

Cathrine Jessen, David Lando

Publikation: Bidrag til bog/antologi/rapportKonferencebidrag i proceedingsForskningpeer review


Distance-to-default is a remarkably robust measure for ranking firms according to their risk of default. The ranking seems to work despite the fact that the Merton model from which the measure is derived produces default probabilities that are far too small when applied to real data. We use simulations to investigate the robustness of the distance-to-default measure to different model specifications. Overall we find distance-to-default to be robust to a number of deviations from the simple Merton model that involve different asset value dynamics and different default triggering mechanisms. A notable exception is a model with stochastic volatility of assets. In this case both the ranking of firms and the estimated default probabilities using distance-to-default perform significantly worse. We therefore propose a volatility adjustment of the distance-to-default measure, that significantly improves the ranking of firms with stochastic volatility.
Titel26th Australasian Finance & Banking Conference 2013
RedaktørerFariborz Moshirian
Antal sider25
Udgivelses stedSydney
ForlagUNSW Australia Business School
ISBN (Trykt)9780987312754
StatusUdgivet - 2013
BegivenhedThe 26th Australasian Finance and Banking Conference 2013 - Shangri-la Hotel, Sydney, Australien
Varighed: 17 dec. 201319 dec. 2013
Konferencens nummer: 26


KonferenceThe 26th Australasian Finance and Banking Conference 2013
LokationShangri-la Hotel


  • Default risk
  • Default prediction
  • Distance-to-default
  • Stochastic volatility


Jessen, C., & Lando, D. (2013). Robustness of Distance-to-Default. I F. Moshirian (red.), 26th Australasian Finance & Banking Conference 2013 Sydney: UNSW Australia Business School.