Financial distress prediction with knock out real options: a study for the argentine market
Abstract
This paper explores default prediction models based on real options theory, proposing a simple model using exotic barrier options. Financial distress prediction models consider the value of net capital as if it were a call option over the firm’s assets. Its main weakness resides in the direct relationship between an asset’s volatility and its option value. For certain critical levels of assets, the knock-out barrier option type inversely adjusts the relationship between volatility and net capital value. Along this line, a naive version of barrier models is proposed for predicting financial distress and calculating default values for firms, sector and the market. First, a case method is employed to make a comparative analysis between the traditional naive model and the naive barrier options. The sensitivity analysis is applied over variables such as volatility, leverage and time horizon, and is implemented over a representative sample of Argentinian market firms. The results obtained indicated that the barrier option model developed better. With increased volatility, net capital value tended to decline, and showed direct correlation between volatility and default probabilities. The model is a useful tool to predict firms’ probabilities and risk of default, at the individual or aggregated level.Keywords:
Real options, Barriers, Default, Default expected valueReferences
Afik, Z, Arada, O y Galil, K. (2015). Using Merton modelo for default prediction: An empirical assessment of selected alternatives. Journal of Empirical Finance, 35, 43-67.
Altman, E. (1968). Financial ratios, discriminant analysis and the predicition of corporate bankruptcy. Journal of Finance, 4, 589-609.
Altmant, E. (1993). Corporate Financial Distress and Bankrutpcy (Second ed.). New York, United State: Wiley Finance.
Altmant, E y Kishore, M. (1996). Almost everything you wanted to know about recoveries on default bonds. Financial Analyst Journal(52), 57-64.
Andrade-Valbuena, N, Moscoso Duran F y Salcedo-Perez, C. (2017). Liquidity, Profitability, Tax rate and Bankruptcy risk in Colombian SMEs. Estudios de Administración, 24(1), 16-32.
Bharath, S y Shumway, T. (2008). Forescasting Default with the Merton distance to default model. Review of Financial Studies, 23, 589-609.
Black, F y Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economics(81), 637-659.
Brockman, P y Turtle, H. (2003). A Barrier Option Framework for Corporate Security Valuation. Journal of Financial Economics, 67, 511-529.
Caro, N, Diaz, M y Porporato, M. (2013). Predicción de quiebras empresariales en economías emergentes: Uso de un modelo logístico mixto. Revista de Métodos Cuantitativos para la Economía y Empresa, 16, 200-2015.
Castro Monge, E. (2010). El estudio de casos como metodología de investigación y su importancia en la dirección y administración de empresas. Revista Nacional de Administración, 2(1), 31-54.
Cochrane, J. (2005). Asset Pricing (2 ed.). Princeton: Princeton University Press.
Copeland, T y Antikarov, V. (2001). Real Options (1 ed.). New York: Texere LLC.
Crosbie, P y Bohn J. (2002). Modeling defaukl risk. San Francisco, United State: KMV Corporation.
Crosbie, P y Bohn, J. (2003). Modeling Default Risk. WP Moody ́s KMV, http://www.business.illinois.edu/gpennacc/moodyskmv.pdf.
Dixit, A y Pindyck, R. (1994). Investment under Uncertainty (1 ed.). New Jersey: Pricenton University Press.
Graziabile, D. (2012). Derecho Concursal. CABA, Argentina: Abeledo Perrot.
Haug Gaarder, E. (2007). Derivatives: Models ond Models (1 ed.). Chichester : John Wiley & Sons.
Hillegeist, S, Keating, E, Cram, D y Lundstedt, K. (2004). Assesing the probability of bankruptcy. Review of Accounting Studies(9), 5-34.
Hull, J. (2005). Futures, Options and other Derivatives (5 ed.). New Jersey: Prentice Hall.
Hull, J. (2012). Options, Futures and other Derivatives (Global Edition). Pearson Education Limited 8va edición.
Jones, P., Masson, S. y Rosenfeld, E. (1984). Contingent Claims Analysis of Corporate Capital Structure: An Empirical Analysis. Journal of Finance, 39, 611-625.
Kodukula, P. y Chandra, P. (2006). Project Valuation using Real Options: A practiioner ́s guide. USA: J Ross Publishing.
Longerstaey, J y Spencer, M. (1996). RiskMetrics Technical Document. RiskMetrics (TM) Morgan Stanley MSCI NY https://www.msci.com/documents/10199/5915b101-4206-4ba0-aee2-3449d5c7e95a.
Maffia, O. (1993). Derecho Concursal. CABA, Argentina: De Palma.Merton, R. (1974). On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance, 29, 449-470.
Milanesi, G. (2013). Teoría de Opciones: Modelos específicos y aplicaciones para valorar estrategias, activos reales e instrumentos financieros (Primera ed.). Bahía Blanca: Editorial de la Universidad Nacional del Sur. REUN.
Milanesi, G. (2014). Momentos estocásticos de orden superior y la estimación de la volatidad implícita: aplicación de la expansión de Edgeworth en el modelo de Black-Scholes. Estudios Gerenciales(30), 336-342.
Milanesi, G. (2016). Un modelo “naive” de opciones barreras para la predicción de fracasos financieros. Estocástica: Finanzas y Riesgo, 6(2), 159-186.
Milanesi, G, Pesce, G y El Alabi, E. (2016). Firm valuation and default probability through exotic (barrier) options. European Accounting and Management Review,2(2), 56-76.
Mun, J. (2004). Real Options Analysis: Tools and Techniques for Valuing Strategic Investment and Decisions (1 ed.). New York: Wiley.
Reiz, A y Perlich C. (2007). A Market-Based Framework of Bankruptcy Prediction. Journal of Financial Stability, 3(2), 85-131.
Rivera, J. (1996). Instituciones del Derecho Concursal. CABA, Argentina: Rubinzal Cunsoni.
Sandin, A y Porporato M. (2007). Corporate bankruptcy prediction models applied to emerging economies: Evidence from Argentina in the years 1991-1998. International Journal of Commerce and Management, 17(4), 295-311.
Smaranda, C. (2014). Scoring functions and bankruptcy prediction models – case study for Romanian companies. Procedia Economics and Finance, 10, 217-226.
Smit, H y Trigeorgis, L. (2004). Strategic Investment: Real Options and Games (1 ed.). New Jersey, Estados Unidos: Princeton University Press.
Trillini, J y Milanesi, G. (2015). La cesación de pagos en los procesos judiciales: Una mirada jurídica a la luz de las finanzas corporativas. Doctrina Societaria y Concursal, XXVII, 21-30.
Van der Hoek, J y Elliot, R. (2006). Binomial models in Finance. New York, United State: Springer Science.
Vasicek, O. (1984). Credit Valuation. WP Moody ́s KMV http://www.ressources-actuarielles.net/EXT/ISFA/1226.nsf/0/c181fb77ee99d464c125757a00505078/$FILE/Credit_Valuation.pdf.
Vasicek, O. (2001). EDF credit measure and corporate bond pricing. San Francisco, United State: KMV corporation.
