The purpose of this paper is to assess the significance of the Merton distance-to-default (DD) in predicting defaults for a sample of listed Indian firms.
The study uses a matched pair sample of defaulting and non-defaulting listed Indian firms. It employs two alternative statistical techniques, namely, logistic regression and multiple discriminant analysis.
The option-based DD is found to be statistically significant in predicting defaults and has a significantly negative relationship with the probability of default. The DD retains its significance even after the addition of Altman’s Z-score. This further establishes its robustness as a significant predictor of default.
The study re-establishes the utility of the Merton model in India using a simplified version of the Merton model that can be easily operationalized by practitioners, reasonably larger sample size and is done in a more recent period covering the post global financial crisis period. The findings could be valuable to banks, financial institutions, investors and managers.
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