Merton-KMV Model vs. S&P Credit Ratings During COVID Volatility: How Well Did the Merton-KMV Model Perform?

This paper studies the comparative performance advantage of the Merton-KMV credit risk model against Standard & Poor’s credit ratings in predicting corporate defaults and bankruptcies during the initial COVID period. We find that the Merton-KMV model’s canonical superiority held despite the sharply elevated equity market volatility and its structural reliance on such equity market inputs. Furthermore, using S&P credit ratings and their equivalent implied probabilities of default as signals for future default, we find that the Merton-KMV model provided significantly earlier warning signals compared to its S&P counterpart.