Distance to Default
Distance to Default is a central concept in Structural Credit Models where it denotes the degree to which the assets of a borrower (in particular in a corporate context) exceed the corresponding liabilities.
The concept originated with the work R. Merton
There is range of variations in how the concept can be used in credit risk modelling:
- A strict interpretation that aims to derive the distance to default from market observables
- A looser intepretation that may use information from financial statements
- As a functional transformation of diverse credit drivers, in particular in the context of Threshold Models
- Merton RC. 1974. On the pricing of corporate debt: the risk structure of interest rates. J. Finance