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Predicting Default – Merton vs. Leland
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This paper is the first to compare the ability of the two structural credit risk models of Merton (1974) and Leland (1994a, b) to predict bankruptcy. We investigate different implementations of the Merton and Leland models on the whole CRSP/Compustat universe of firms from 1980 to 2015. Although the Leland model has several theoretical advantages, such as an endogenously defined default barrier and flexible maturity of debt, we find the out-of-sample predictive accuracy of the standard Merton model to be far superior.
Title: Predicting Default – Merton vs. Leland
Description:
This paper is the first to compare the ability of the two structural credit risk models of Merton (1974) and Leland (1994a, b) to predict bankruptcy.
We investigate different implementations of the Merton and Leland models on the whole CRSP/Compustat universe of firms from 1980 to 2015.
Although the Leland model has several theoretical advantages, such as an endogenously defined default barrier and flexible maturity of debt, we find the out-of-sample predictive accuracy of the standard Merton model to be far superior.
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