The Probability of Default and Its Design of Experiment

The Probability of Default and Its Design of Experiment

Amir Ahmad dar (B. S. Abdur Rahman Crescent Institute of Science and Technology, India) and N. Anuradha (B. S. Abdur Rahman Crescent Institute of Science and Technology, India)
Copyright: © 2020 |Pages: 32
DOI: 10.4018/978-1-5225-8458-2.ch010


The Merton Model is the critical model for financial economics to measure the default of a firm. It was the first structural model because it uses the market value of the firm for estimating the default of the firm. The firm will be in default only when the values of the firm goes down to a threshold value (the debt of the firm), and if it occurs, the owner will put the firm to the debt holders. The effects of parameters-asset value V, firms debt D, interest rate r, the volatility σ, and period T on the probability of default was investigated. To estimate the probability of default of a firm, the Black Scholes Model for European call options is used. The aim is to determine which parameter effects more or less on the probability of default. The experiment is based on the orthogonal array L27 in which the five factors (parameters) are varied at three levels. The Taguchi L27 orthogonal method, ANOM, and ANOVA are used to examine the effect of these parameters on the probability of default. It also provides the best combination where the probability of default is minimum.
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Literature Review

The Taguchi methods are often used in industrial experiments to investigate the effects of several factors. It is used in every field such as education, engineering, physics, chemistry, environmental science, and so forth. The Taguchi method is a methodical proposal for expansion of different factors with considering to performance, cost, and quality. The standard value of a product is estimated by standard characterizes such as larger is better, nominal is the best, smaller is better (Phadke, 1989; Roy, 2001; Phadke, 1998). Chan et al. (2014) investigated the effect of four parameters; catalyst loading, type of catalyst, reaction temperature and the nitrogen gas on liquid yield (bio-oil). The catalyst loading affects more on liquid yield than others. Shravani et al. (2011) used the Taguchi L9 orthogonal array design to measure the optimized formulation of duloxetine hydrochloride.

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