The purpose of this study is to test predictive ability of Merton model for credit risk and to examine market factors affecting bond price in speculative grade bonds in Korea. To estimate credit premium, basic Merton technique is used. Market factors are examined with regression analysis for differences between market rate and fitted rate. There are three major results: (1) Fitted rate with Merton model can be used to explain market rate in speculative grades bonds even though the model underpredicts the spreads of speculative grades bonds. (2) Liquidity and tax can have effects on market rate of speculative grades bonds (3) The difference between market rate and fitted rate with Merton model can be explained by other effects except for liquidity and tax.
