Explaining Credit Ratings of Australian Companies—An Application of the Merton Model

This paper examines how the default likelihood indicator computed from the option-based model of Merton (1974) together with two default-related factors, namely firm size and book-to-market ratio, effectively explain credit ratings when compared to accounting ratios. Using Australian companies that are rated by Standard and Poor's during 1992–2003 and ordered probit analysis we find that the market-based model is more informative in explaining credit ratings than the accounting-based model.