Assessing Default Risk of Israeli Companies Using a Structural Model

The aim of this study is to asses the default probabilities of public companies and to explore the extent to which these probabilities explain bond prices in the market. These questions are examined under the framework that was proposed by Merton to price corporate debt, applied on a large number of public companies listed on the Tel Aviv Stock Exchange in the period 2005-2010. The data is cross-checked with a list of companies that underwent debt repayment difficulties during that period, which includes the 2008 financial crisis. The results show that the model is able to identify problematic firms some time in advance, though with significant errors in identification. The results also show that default risk can explain only a small part of the corporate bond spreads, while other market risks along with the introduction of bankruptcy cost assumptions can contribute considerably to the explanatory power of the model