Explaining Credit Ratings of Australian Companies-An Application of the Merton Model

Abstract

This paper examines how the default likelihood indicator computed from the option-based model of Merton (1974) together with two default-related factors, namely firm size and book-to-market ratio, effectively explain credit ratings when compared to accounting ratios. Using Australian companies that are rated by Standard and Poor's during 1992-2003 and ordered probit analysis we find that the market-based model is more informative in explaining credit ratings than the accounting-based model. Show more