In order to obtain the probability of default in the Merton (1974)model under the real-world probability measure,we need to make the following change in calculating $N \left( d _ { 2 } \right)$ in the formula :
A)Replace $\mu$
(the firm's asset growth rate)with
$r$
(the risk-free rate).
B)Replace $r$
With
$\mu$
)
C)Replace $\sigma$
(the firm's asset volatility)with
$d _ { 1 } \sqrt { T - t }$
)
D)Replace $d _ { 2 }$
With
$\sigma \sqrt { T - t }$
)

Question

In order to obtain the probability of default in the Merton (1974)model under the real-world probability measure,we need to make the following change in calculating $N \left( d _ { 2 } \right)$ in the formula :
A)Replace $\mu$
(the firm's asset growth rate)with
 $r$
(the risk-free rate).
B)Replace $r$
With
 $\mu$
)
C)Replace $\sigma$
(the firm's asset volatility)with
 $d _ { 1 } \sqrt { T - t }$
)
D)Replace $d _ { 2 }$
With
 $\sigma \sqrt { T - t }$
)

Quizplus · Accepted Answer

In the Merton model, to switch from the risk-neutral measure to the real-world measure, the drift term $\mu$ (the firm's asset growth rate) should replace the risk-free rate $r$ in the calculation of $N(d_2)$.

In Order to Obtain the Probability of Default in the Merton