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calibrating a barrier model a barrier model

Calibrating a Barrier Model

A barrier model describes the event of default as the first time the market value of the firm falls below a critical value. For special cases a closed form solution exists. In general a simulation approach is used.

There are a number of issues that must be settled before running a simulation.

Part (A)

How do you determine the value of the firm, A(t0) ?

Part (B)

How do you determine the volatility of the describing the change in firm value, σ?

Part (C)

How do you determine the level of the barrier?

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