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marginal probability of default in Merton?

ajsa

New Member
Hi David,

Could you take a look? I think answer B is consistent with the Stulz's empirical finding (the "credit spread"), but it is not from Merton model.. could you clarify?

thanks.

In Merton’s model, the marginal probability of default _________ with maturity for
companies with a high initial credit rating and __________ with maturity for companies
with a low initial credit ratings.
a. increases, increases
b. increases, decreases
c. decreases, increases
d. decreases, decreases
CORRECT: B
The increase for high credit rating is due to a mean reversion effect and the decrease for
low credit ratings is due to the survival effect. The fortunes of an Aaa-rated firm can only
stay the same at best, but will often deteriorate, while a B-rated firm that has survived the
first few years must have a decreasing probability of defaulting as time goes by.
 
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