Python for Finance - Second Edition

Using the KMV model to estimate the market value of total assets and its volatility

KMV stands for Kealhofer, McQuown and Vasicek who founded a company focusing on measuring default risk. KMV methodology is one of the most important methods to estimate the probability of default for a given company by using its balance sheet information and the equity market information. The objective of this section is to show how to estimate the market value of total assets (A) and its corresponding volatility (σA). The result will be used later in the chapter. The basic idea is to treat the equity of a firm as a call option and the book value of its debt as its strike price. Let's look at the simplest example. For a firm, if its debt is $70 and equity is $30, ...