Structural Default Risk Modeling with Soft Budget and Empirical Evidences

Merton´s equity-based approach is considered as a pioneering tool for measuring default risks. But in developing countries, we find that the invalid priority principle of Merton´s model-because of the existing soft constraint-put negative influence on the applicability of the model. Bringing soft constraint into consideration, we establish a new model, which adds a new parameter thetas to describe the soft constraint. By simulation, we can make the conclusion that thetas and P (the value of debt) is in a positive correlation. The final empirical evidences convincingly support the feasibility and rationality of the new method.