Credit Analysis: Implications of Structural Models on Default Risk

Hard Credit Analysis And Valuation Structural Models

In the context of credit analysis for corporate bonds, structural models of credit risk provide a framework for understanding the likelihood of default by mapping a firm’s asset value and liabilities. A commonly used structural model is the Merton model, which equates the equity of a firm to a call option on its assets. Assume a firm has an asset value that follows a stochastic process modeled as geometric Brownian motion. Given this context, which of the following statements about the implications of using a structural model for assessing default risk is most accurate?

Structural models inherently account for the non-linear relationship between asset value and default probability without requiring any empirical input.

Structural models primarily rely on the firm's current asset value and do not incorporate the volatility of the firm's assets.

Structural models suggest that an increase in the volatility of asset returns generally leads to an increase in the probability of default.

Hint

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