Empirical Studies of Structural Credit Risk Models and the Application in Default Prediction: Review and New Evidence

Abstract

This paper first reviews empirical evidence and estimation methods of structural credit risk models. Next, an empirical investigation of the performance of default prediction under the down-and-out barrier option framework is provided. In the literature review, a brief overview of the structural credit risk models is provided. Empirical investigations in extant literature papers are described in some detail, and their results are summarized in terms of subject and estimation method adopted in each paper. Current estimation methods and their drawbacks are discussed in detail. In our empirical investigation, we adopt the Maximum Likelihood Estimation method proposed by Duan [Mathematical Finance 10 (1994) 461-462]. This method has been shown by Ericsson and Reneby [Journal of Business 78 (2005) 707-735] through simulation experiments to be superior to the volatility restriction approach commonly adopted in the literature. Our empirical results surprisingly show that the simple Merton model outperforms the Brockman and Turtle [Journal of Financial Economics 67 (2003) 511-529] model in default prediction. The inferior performance of the Brockman and Turtle model may be the result of its unreasonable assumption of the flat barrier.

Partially Observable Markov Decision Processes and Periodic Policies With Applications

“…5,27,28 Since an information request is essentially a database query, an important component of such systems is the manner in which the queries are processed. Control policies for distributed queries are useful for locating the appropriate sources of the information as quickly or as cheaply as possible.…”

“…6,32 In an attempt to diagnose a patient, the physician has a number of actions available: conduct laboratory tests, prescribe drug treatments, perform exploratory surgery, or recommend various forms of physical therapy. Each of these incurs a cost to the patient, both in monetary units and in terms of health risks.…”

“…[1][2][3][4][5][6][7][8][9][10] Unfortunately, the computational burden associated with solving POMDPs is overwhelming, precluding their application to problems of practical size. [11][12][13] Computing the exact optimal finite or infinite horizon solution of a POMDP is generally extremely computationally intractable.…”