Using Option Theory and Fundamentals to Assessing Default Risk of Listed Firms

In this paper, we use option based measures of financial performance that utilize market information in a binary probit regression to examine their informational context and properties as distress indicators and to estimate default probabilities for listed firms. Then, we enrich them with fundamentals that utilize accounting information. The results suggest that by adding accounting information from financial statements to market information from equity prices we can improve both in sample fitting and out of sample predictability of defaults. Therefore, option theory does not generate sufficient statistics of the actual default frequency. Our main conclusion is that while market information can be extremely valuable, it is most useful when coupled with accounting information in assessing default risk of listed firms.