Structural credit model
Principles of Finance glossary · Principles Of Finance
Definition
A credit model (Merton 1974) in which equity is valued as a call option on firm assets.
Structural credit model in plain English
A structural credit model is a clever way to estimate how likely a company is to default on its debt by looking at the value of everything the company owns (its assets). The key insight, from a 1974 idea by Robert Merton, is that owning a company's stock is like holding an option: shareholders only get paid after lenders are fully repaid, so they effectively have the right -- but not the obligation -- to 'buy back' the company's assets by paying off the debt. If the assets are worth more than the debt, shareholders come out ahead; if not, they can walk away and let lenders take the assets. Treating equity as this kind of call option lets analysts translate the ups and downs of a firm's asset value into the odds it can't cover what it owes.
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