A Default Probability Estimation Model: An application to Japanese companies

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A Default Probability Estimation Model: An application to Japanese companies

by Masatoshi Miyake of the Tokyo University of Science, and
Hiroshi Inoue of the Tokyo University of Science

August 2009

Abstract: On the assumption that asset value of a company is the sum of total market value of stock and debt value, we estimate a mean value and variance of the sum with the first moment and second moment. We also assume a new variable for which fluctuation during an evaluation period conforms to these moments and follows geometric Brownian motion. Then we construct a default probability estimation model on condition that the variable is regarded as the asset value of the company. For constructing expected default probability (EDP) model, we partially follow Levy’s way [8], in which a new variable used for average option is assumed. Thus its evaluation formula is derived. In addition, concerning estimated values of the default probability, our model is examined by comparing with the conventional structural approach with respect to the company in Japan, where default was actually caused and the company is free from the default.

Keywords: expected default probability (EDP), moment, Black-Scholes-Merton model.

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