Merton’s Model in Credit Risk Modelling

In this short paper, we first present the Merton’s model, a fundamental model for credit risk modeling. Merton’s model is a structural model of default in which default occurs at the maturity when the market value of the company’s assets fall below a pre-determined threshold defined by liabilities. We then describe the default probability of the company and show some comparative statics analysis.Also, we show some well known strengths and drawbacks of the model. And finally, some models derived Merton’s model such as CreditMetrics, KMV model and Credit Risk plus are described.