This study aims to examine the usefulness of the extension Merton’s Distance to Default (DD) model, one of the structural models used to measure the credit risk, in terms of making profits by long-short trading strategy. We select Spread Sheet version of DD model suggested by Han Ne Bystrom (2006) and Naïve DD model by Bharath and Shumway (2008) as they were suggested as a simpler way to calculate the Distance to Default and were indicated to have a better result in predicting financial distress than the original Merton DD model. Therefore, we will use the concept of momentum strategy and financial distress model that based on long winner and short loser. The zero-portfolio constructed including a long position in high DD value (safe stocks) and a short position in short DD value stocks (risky stocks) is examined whether the strategy can earn an abnormal return. We test this strategy in Thailand market that is the SET and MAI market. From the empirical result, this active trading strategy can earn short run abnormal profit only in the MAI market.
Profitability of buying safe and selling risky securities as detected by the financial distress model: case of listed companies in Thailand
Post by MSF Chula at Friday, 8 January 2021 10:39 PM
Last updated at Friday, 8 January 2021 10:39 PM