Unobserved firm volatility is an obstacle in the implementation of the Merton model.One popular way to overcome this is to
A)Use the model only on non-financial firms.
B)Use equity prices to back out firm volatility.
C)Use equity volatility in place of asset volatility in implementing the model.
D)Use data on closely-related firms from the same sector to infer this volatility.

Question

Quizplus · Accepted Answer

Using equity prices to back out firm volatility is a popular and effective way to overcome unobserved firm volatility in the implementation of the Merton model. This approach involves using the market value of equity and the risk-free rate to estimate the firm's equity volatility, which can then be used to derive the asset volatility necessary for the model. This approach is widely used in practice and has been found to produce robust results.

Unobserved Firm Volatility Is an Obstacle in the Implementation of the Merton