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Forecasting the Probability of Default of PN17 Company using KMV-Merton Model

M. Y. Norliza, M. J. Maheran

Abstract



The paper gives an overview on the application and validation of KMV-Merton model in forecasting the probability of default of PN17 Company. KMV-Merton model is a well-known model used to calculate the probabilistic assessment of firms’ likelihood to default. In this paper, the model is applied to a company called Mithril Berhad as a sample data of PN17 Company. Mithril Berhad is listed as PN17 Company by Bursa Malaysia Securities Berhad in 2010. Generally, PN17 Company is presumed as a company within financial difficulty. In addition, KMV-Merton model is said to be able to forecast the future default of a company up to two years in advance. Therefore, adaptation and validation of the KMV-Merton model in forecasting the future default of Mithril Berhad is done in this paper. Adaptation involves the estimation of book value of liabilities, market value of asset, asset volatility, expected asset returns, distance to default and probability of default of Mithril Berhad. Validation is done by estimating the probability of default of Mithril Berhad at the year of 2008, which is two years earlier before it is found listed as PN17. The rating given to Mithril Berhad at any year after 2008 is also used to reaffirm the validation process. Apparently, the probability of default of Mithril Berhad is forecasted high two years before it is listed as PN17 Company and three years before it is rated as D by Malaysian Rating Corporation Berhad. This shows that the KMV-Merton model is indeed able to forecast future default of PN17 Company. Therefore, KMV-Merton model is concluded as a potential model for investor or any organizations to forecast the probability of default of PN17 Company.

Keywords


Probability of Default, PN17 Company, KMV-Merton Model, Forecast, Credit Risk.

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