An iterated Merton-KMV based approach of default risk prediction

• Published in: AIP Conference Proceedings
• Main Author: Yusof N.M.; Alias S.N.H.; Rosli N.A.; Rosna W.N.A.W.; Sapini M.L.
• Format: Conference paper
• Language: English
• Published: American Institute of Physics Inc. 2018
• Online Access: https://www.scopus.com/inward/record.uri?eid=2-s2.0-85054573974&doi=10.1063%2f1.5054220&partnerID=40&md5=9a91f78862b9d5017156b50955cd4325

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. © 2018 Author(s).