Which model is primarily focused on the estimation of default risk using structural approaches?

• A. Ho and Lee model
• B. KMV model
• C. Black-Derman-Toy model
• D. Merton model

Answer: (B)

The Merton model is primarily focused on the estimation of default risk using structural approaches, as it offers a framework to assess a firm's credit risk based on its capital structure and the value of its assets. The model represents a company's equity as a call option on its assets, where the debt acts as the strike price. If the value of the firm's assets is below the debt level at maturity, a default occurs. This structural approach links the value of the firm and its debt obligations directly to default probability, making it a foundational concept in credit risk modeling.

While other models, such as the KMV model, also deal with default risk, they tend to use a more empirical or statistical approach rather than a structured theoretical framework based on option pricing. The KMV model builds upon the Merton framework but incorporates market data to adjust the measures of credit risk, which diverges from a pure structural approach. The Ho and Lee and Black-Derman-Toy models primarily address interest rate modeling and derivative pricing, rather than directly focusing on default risk from a structural viewpoint. Thus, the Merton model serves as the most direct answer regarding structural approaches to estimating default risk.