Abstract
SYNOPTIC ABSTRACTWe expand the Merton's structural credit risk model into a model that includes an underlying asset process with a non-Gaussian and serially correlated stochastic nature. Using a standard Edgeworth expansion, we arrive at closed-form analytic expressions for the probability of default, the distance to default, and the term structure of credit spread, allowing us to evaluate more accurately the credit risk of incorporating nonnormal asset returns. Moody's KMV (Kealhofer, McQuown, and Vasicek) analogous procedures are proposed for the estimation of the model parameters. Empirical applications for credit-risk evaluation are illustrated, which reveal the significant effects on credit risk due to the non-Gaussianity of the underlying firm's asset process.
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