Exploiting default probabilities in a structural model with nonconstant barrier

Abstract

Structural models have been developed and used in financial literature to assess the probability of default of corporations. This article aims at reversing this approach, using this probability as an input and investigating if the default barrier can be considered flat, as done in similar analysis, or should more appropriately be time-varying.

Keywords:

• default structural models
• default implied probability
• nonconstant barrier options
• KMV model

JEL Classification::

• G13
• G33

Notes

¹ For sake of simplicity we omit the ‘dividend yield’ parameter present in the original formulation.