Quantitative analysis of credit default risk Assessment using black-scholes-merton Model: a case study of the Kenyan Manufacturing industry

Abstract

The Kenyan manufacturing industry is a major contributor of the country’s economy, contributing significantly to GDP growth, job creation, and export opportunities. However, despite its undeniable significance, the Kenyan manufacturing industry is grappling with several challenges that are hampering its growth, with credit constraints being a prominent issue. These challenge often lead to financial distress, forcing some companies to shut down or operate below their optimal potential.This research introduces the Black-Scholes Merton model, an eminent financial tool developed for option pricing, and proposes its adaptation to the context of the Kenyan manufacturing industry. The model is applied to gauge the default probabilities of manufacturing firms by integrating company-specific financial data, volatility, and credit risk factors to assess default risks. The study is based on financial reports published for sampled manufacturing companies in Kenya for the financial years 2016 to 2022. The variables used to compute the probabilities of default are total assets, time period, volatility, debt and risk-free interest rate. The data analysis shows that default probabilities are directly proportional to the company’s liabilities. This research is a comprehensive guide to the assessment, analysis and credit management.