KMV and sigma

[Its_Coming]

Slightly confused and need claification...

DD = (E(V1) / DPT)/sigma

then given the lognormal assumption, the formuls uses sigma^2. This leads me to believe sigma is the standard deviation and sigma^2 is the volatility.

But, then in the book's example of DD (using Fed Ex financials?) they divide by a given volatility, not std dev.

I know its a little late in the game, but this one is bugging me. Any thoughts??

Stressed and Tired,

[sharkie21]

1) DD = E(V1) - DPT / sigma

2) DD = Ln(V/DPT) + (u-1/2sigma^2)T / sigma sqrt(T)

It seems it's like the annual asset volatility in dollar measure for first formula.

In the second formula it seems like it's the asset volatility?

when I plug in the numbers from ex 1 into the 2nd formula I get a DD = 4.18 with V = 1000, DPT = 800, u = 0.2, sigma = 0.1 T = 1

I'm just as confused as you I guess.

[happynsweet]

The lognormal formula is d2 from black-scholes pricing, so if you think about it that way, the vols, means, are in percents.

For the first formula, you can use dollars or percents if you want it on the same basis as your lognormal formula. Just divide everything by current MV(Assets).

However, both should lead to similar results because you are looking at ratios and the units cancel out in the first formula (dividing dollars in the numerator by dollars in the denominator)