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Corporate valuations and the merton model

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  • Andrea Gheno

Abstract

In recent years both practitioners and academics have realised that traditional discounted cash flow models erroneously consider the option value embedded in firms. Hence equity and debt valuation methodologies based on option theory have recently become quite popular. Such methodologies take inspiration from the Merton (1974) model which was originally introduced to measure the impact of default risk on corporate bonds yields. Thirty years later the Merton model for its simplicity and rigour remains unrivalled and is the basis of some of the most sophisticated credit risk models. In this paper it will be shown how practitioners often improperly adapt the Merton model for aims beyond its original scope.

Suggested Citation

  • Andrea Gheno, 2005. "Corporate valuations and the merton model," Departmental Working Papers of Economics - University 'Roma Tre' 0055, Department of Economics - University Roma Tre.
    • Handle: RePEc:rtr:wpaper:0055
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    File URL: http://host.uniroma3.it/dipartimenti/economia/pdf/wp55.pdf
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    References listed on IDEAS

    as
    1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    3. Marisa Cenci & Andrea Gheno, 2005. "Equity and debt valuation with default risk: a discrete structural model," Applied Financial Economics, Taylor & Francis Journals, vol. 15(12), pages 875-881.
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    More about this item

    Keywords

    Merton model; option pricing; default risk; corporate bond.;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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