Towards a “market continuum”? Structural models and interaction between credit and equity markets
AbstractThe theory of the firm developed by Merton in the 1970s shows how the two financing instruments used by firms, i.e. equity and debt may be viewed as options on the value of their assets. Thus, a shareholder may be regarded as a holder of a call option on the firm’s assets, while a lender may be seen as a seller of a put option on these same assets. So-called structural models derived from this theory have been developed in recent years. They formalise the relationship between equity and debt, and more specifically, endeavour to assess the credit risk attached to each individual issuer on the basis of accounting data, such as its level of debt, and equity market data, such as volatility and stock prices. This article aims to describe these models and analyse the effect of the use of these models on capital markets from the perspective of financial stability. By fostering interactions between asset classes, their increased use has opened up the different market segments and, ultimately, has contributed to the creation of a market continuum. This type of quantitative analysis is thus likely to improve the way financial asset prices are formed, making relative asset prices more coherent and homogeneous. Developing models based on this approach is nevertheless a complex task and the relevance of this whole approach may be called into question if it gives rise to oversimplification or excessive confidence in the signals produced by such models. Structural models add to the spectrum of instruments for credit risk analysis at market participants’ disposal, but are not intended to replace them.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Banque de France in its journal Financial stability review.
Volume (Year): (2003)
Issue (Month): 2 (June)
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Clerc, L., 2007. "Understanding Asset Prices: Determinants and Policy Implications," Working papers 168, Banque de France.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marie-Christine Petit-Djemad).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.