Merton's Model, Credit Risk and Volatility Skews

Posted: 28 Apr 2005

See all articles by John C. Hull

John C. Hull

University of Toronto - Rotman School of Management

Izzy Nelken

Super Computer Consulting, Inc.

Alan White

University of Toronto - Rotman School of Management

Abstract

In 1974 Robert Merton proposed a model for assessing the credit risk of a company by characterizing the company's equity as a call option on its assets. In this paper we propose a method for estimating the model's parameters from the implied volatilities of options on the company's equity. We use data from the credit default swap market to compare our implementation of Merton's model with the traditional approach to implementation.

Keywords: Merton's model, credit risk, volatility skews, credit default swap market

Suggested Citation

Hull, John C. and Nelken, Izzy and White, Alan, Merton's Model, Credit Risk and Volatility Skews. Available at SSRN: https://ssrn.com/abstract=707603

John C. Hull (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
(416) 978-8615 (Phone)
416-971-3048 (Fax)

Izzy Nelken

Super Computer Consulting, Inc. ( email )

3943 Bordeaux Drive
Northbrook, IL
United States

Alan White

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-978-3689 (Phone)
416-971-3048 (Fax)

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