Expected Default Probabilities in Structural Models : Empirical Evidence

We apply a set of structural models (Merton (1974), Black and Cox (1976), Longstaff and Schwartz (1995), Leland and Toft (1996), Ericsson and Reneby (1998) and Collin-Dufresne and Goldstein (2001)) to estimate expected default probabilities (EDPs) for a sample of failed and non-failed UK real estate companies. Results are generally consistent with models' predictions, and the estimates of EDPs for different models are closely clustered. The results of z-scores and synthetic ratings misclassify 33 percent of the total sample in contrast to 8 percent misclassification by structural models. Further analysis of EDPs based on logistic regressions suggests the observed misclassification of the companies by structural models is due to special company management and/or regulatory circumstances rather than limitations of these models