Investigating the performance of alternative default-risk models: Option-based versus accounting-based approaches

Gharghori, Philip, Chan, Howard and Faff, Robert (2006) Investigating the performance of alternative default-risk models: Option-based versus accounting-based approaches. Australian Journal of Management, 31 2: 207-234. doi:10.1177/031289620603100203

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Author Gharghori, Philip
Chan, Howard
Faff, Robert
Title Investigating the performance of alternative default-risk models: Option-based versus accounting-based approaches
Journal name Australian Journal of Management   Check publisher's open access policy
ISSN 0312-8962
1327-2020
Publication date 2006-12
Sub-type Article (original research)
DOI 10.1177/031289620603100203
Volume 31
Issue 2
Start page 207
End page 234
Total pages 28
Place of publication London, United Kingdom
Publisher Sage Publications
Language eng
Formatted abstract
In this paper we evaluate the performance of three alternate default-risk models, seeking to find that measure which performs best, using a comprehensive sample drawn from the Australian equities market. The first two models are option-based models and are derived from Merton's (1974) insight that equity can be viewed as a call option on a firm's assets. In the first model, equity is modelled as a standard call option. In the second model, equity is modelled as a path-dependent barrier option. The third model is created using accounting ratios and is similar to Altman's (1968) Z-Score. To assess which of the models is superior, we consider variations of each model and then rely on prediction-oriented tests that focus on whether a firm subsequently defaults. Our results show that the option-based models clearly outperform their accounting ratio counterparts. Furthermore, our analysis suggests that the option-based models are very successful at ranking firms by default probability. It is noteworthy that the performances of the option-based models are difficult to distinguish from each other.
Keyword Default-risk models
Default prediction
Q-Index Code C1
Q-Index Status Provisional Code
Institutional Status Non-UQ

Document type: Journal Article
Sub-type: Article (original research)
Collections: ERA 2012 Admin Only
UQ Business School Publications
 
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Created: Mon, 07 Mar 2011, 10:55:05 EST by Karen Morgan on behalf of UQ Business School