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

Quizplus · Accepted Answer

In the Merton model, under the real-world probability measure, the drift term $\mu$ is used instead of the risk-neutral drift $r$ when calculating $N(d_2)$.

In Order to Obtain the Probability of Default in the Merton