Abstract:
This paper applies the Merton [Merton, R., 1974, On the pricing of corporate debt: the risk structure
of interest rates. J. Finance 2 (2), 449-470] default probability model to the firms in the SET50 index
at the Stock Exchange of Thailand (SET). It also examines the relationship between a firm's default
probability and firm-specific characteristics like size and book-to-market ratio, and whether default
risk is systematic or not. We believe this to be the first paper dealing with these issues using data
from an emerging country. The study also differs from other studies by dealing with how the default
risk of firms in different sectors of the economy changes during a severe crisis. Overall, we find a
significant increase in market based default probabilities around the crisis and a fairly slow return to
pre-crisis levels, The first sector to suffer a deterioration in creditworthiness was the sector of finance
and securities firms and the worst effected sector at the peak of the Asian crisis was the building
materials sector. There are further some indications of the most distressed firms being on average
somewhat smaller than the least distressed, but only during the crisis. We do not find significant
evidence ofthe book-to-market ratio being related to the default risk in this particular market, though.
Finally, if default risk is systematic, one would expect that default risk is rewarded by higher returns,
However, in this sample the level of default risk of a finn does not seem to be able to explain the firm's subsequent realized returns at different horizons. We therefore reject the hypothesis that default risk
is systematic.
