FRM Glossary · Part II · Credit Risk

Merton Structural Model

Models default as the firm's asset value falling below a debt barrier — the Black–Scholes-style structural credit model.

In more detail

In Merton's 1974 model, equity is a call option on the firm's assets with strike equal to debt; default occurs at maturity if asset value < debt. Distance-to-default and the default probability emerge from asset drift, volatility, and leverage. Extensions (KMV/Vasicek) use a short-term default boundary and are widely used for PD estimation.