Question
You are in employed in a risk management group within a bank. Your boss uses a Merton structural model to estimate the probability that a
You are in employed in a risk management group within a bank. Your boss uses a Merton structural model to estimate the probability that a company defaults for justifying a potential loan to this company to more senior man- agement. The company has a very complicated balance sheet with many different assets and liabilities outstanding. Your boss estimates the default probability by calibrating both the value of the assets of the firm and the asset's volatility. Is this default probability a valid estimate of the actual default probability? Why or why not? Explain.
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