I recently come across Merton's model to estimate the default probability and recovery rate of the company. Here is the inputs
Market value of equity = 4,242,509,661 Debt to be paid = 3,397,334,000 equity Volatility = 34% Risk-free rate = 0.38% Time to maturity = 2.29
I simply follow the way that Chapter 20 in John Hull 6th edition suggested, in which excel "solver" is used to find the total market value of the asset and its volatility. However, the result is strange and I cannot get positive expected loss and recovery rate greater than 1.
For your information, I initialize
V = 7,500,000,000 sig_V = 10%
But the solution becomes
V = 7,500,000,000 sig_V = 19% Expected loss = 0.0046807 Recovery rate = 8.2132 > 1
If I initialize
V = 7,619,759,237 sig_V = 10%
Then, the solution becomes,
V = 7,619,759,237 sig_V = 19% Default probability = 0.00304 Recovery rate = 0.04853
Did anyone come across the Merton's model before? Can anyone explain what's wrong of the model or what I did? Thanks.