Chapter 18. Credit Risks and Credit Derivatives [CR–5]
Using the Merton model, calculate the value of a firm’s debt and equity and the volatility of firm value.
Explain the relationship between credit spreads, time to maturity, and interest rates.
Explain the differences between valuing senior...
Below I am trying to show the relationship between Merton PD and the BSM.
Merton PD = N[ -[ln(V/K)+(μ-0.5σ²)T]/σT ]
The formula inside the bracket (let’s name it D2 since it) is very similar to the formula for d2 in the BSM for pricing call option:
d2 = ln(S/X)+(r-0.5σ²)T]/σT
So we have...
Since we get a lot of questions on Merton (some issues are merely notational), I wanted to collect my observations into a single place. I hope you like. (fwiw, I don't endorse it, I blame the prominence of this on Stulz' influence in the FRM :rolleyes: ... the math of the BSM is admittedly...