Assessing default risk of Israeli companies using a structural model
The goal of this research is to estimate the probability of default by companies, and to examine the extent to which the default risk explains market prices of Tel Aviv Stock Exchange (TASE)-traded bonds. The paper examines these issues within the framework of the model proposed by Merton for pricing tradable debt securities, implemented on a large number of companies whose equities traded on the TASE between 2004 and 2010. These companies are matched against a database which includes all the companies that entered a debt restructuring process during the course of the financial crisis starting in 2008. The results show that the model does in fact provide the ability to predict which companies would encounter distress, though with notable errors in identification. The research also shows that default risk explains only a very small part of the corporate bond price spread observed in the market-whiles other market risks, along with assumptions about the costs of bankruptcy, can contribute to explaining these spreads.