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Abstract

The structural approach offers an integrated framework to deal with yield spreads and default probability simultaneously. However, structural models perform poorly in predicting corporate bond spreads. It is unclear whether this poor performance is caused by characteristics of individual models, missing factors, or different calibration procedures. This study evaluates the performance of four structural models by incorporating two important factors, personal taxes and the liquidity factor, and calibrating these models to data. To ensure our results are not contingent on the calibration method, we further apply the maximum likelihood estimation method to a large sample of individual bonds. Results consistently show that the ability of structural models to predict spreads improves considerably when personal taxes and liquidity are taken into account. Our findings suggest that the poor performance of standard structural models is more likely due to missing factors than the characteristics of individual models or the calibration procedure.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 34 (2010)
Issue (Month): 7 (July)
Pages: 1700-1718

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Handle: RePEc:eee:jbfina:v:34:y:2010:i:7:p:1700-1718

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Related research

Keywords: Default Personal taxes Liquidity Yield spreads Structural models;

References

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1. Li, Ka Leung & Wong, Hoi Ying, 2008. "Structural models of corporate bond pricing with maximum likelihood estimation," Journal of Empirical Finance, Elsevier, vol. 15(4), pages 751-777, September.
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11. André Güttler & Mark Wahrenburg, 2007. "The Adjustment of Credit Ratings in Advance of Defaults," Working Paper Series: Finance and Accounting 155, Department of Finance, Goethe University Frankfurt am Main.
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    • Pierre Mella-Barral & William R M Perraudin, 1993. "Strategic Debt Service," CEPR Financial Markets Paper 0039, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
14. Jarrow, Robert & Li, Haitao & Liu, Sheen & Wu, Chunchi, 2010. "Reduced-form valuation of callable corporate bonds: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 95(2), pages 227-248, February.
15. Liu, Sheen & Shi, Jian & Wang, Junbo & Wu, Chunchi, 2007. "How much of the corporate bond spread is due to personal taxes?," Journal of Financial Economics, Elsevier, vol. 85(3), pages 599-636, September.
16. Anderson, Ronald W. & Sundaresan, Suresh & Tychon, Pierre, 1996. "Strategic analysis of contingent claims," European Economic Review, Elsevier, vol. 40(3-5), pages 871-881, April.
17. Guttler, Andre & Wahrenburg, Mark, 2007. "The adjustment of credit ratings in advance of defaults," Journal of Banking & Finance, Elsevier, vol. 31(3), pages 751-767, March.
18. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
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Cited by:

1. Gemmill, Gordon & Keswani, Aneel, 2011. "Downside risk and the size of credit spreads," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 2021-2036, August.
2. Chen, Tsung-Kang & Liao, Hsien-Hsing & Tsai, Pei-Ling, 2011. "Internal liquidity risk in corporate bond yield spreads," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 978-987, April.
3. Chen, Tsung-Kang & Chen, Yan-Shing & Liao, Hsien-Hsing, 2011. "Labor unions, bargaining power and corporate bond yield spreads: Structural credit model perspectives," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 2084-2098, August.
4. Jankowitsch, Rainer & Nashikkar, Amrut & Subrahmanyam, Marti G., 2011. "Price dispersion in OTC markets: A new measure of liquidity," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 343-357, February.

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