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Performance and determinants of the Merton structural model: Evidence from hedging coefficients

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  • Barsotti, Flavia
  • Viva, Luca Del

Abstract

We empirically test the effectiveness of the Merton (1974) model in measuring the sensitivity of corporate bond returns to changes in equity value. We study the main variables that affect the performance of the model and relax the assumption of normally distributed rates of return. Results show that less than 6% of the bonds have a hedge ratio within 10% from the model predicted value. Volatility, time to maturity, size, distress, liquidity and information quality are found to be significant determinants of the efficacy of the model.

Suggested Citation

  • Barsotti, Flavia & Viva, Luca Del, 2015. "Performance and determinants of the Merton structural model: Evidence from hedging coefficients," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 95-111.
    • Handle: RePEc:eee:jbfina:v:58:y:2015:i:c:p:95-111
    DOI: 10.1016/j.jbankfin.2015.04.007
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    Cited by:

    1. Liang, Jin & Zhao, Yuejuan & Zhang, Xudan, 2016. "Utility indifference valuation of corporate bond with credit rating migration by structure approach," Economic Modelling, Elsevier, vol. 54(C), pages 339-346.

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    More about this item

    Keywords

    Credit risk; Hedge ratios; Corporate bond spreads; Spread sensitivity; Distress; Variance Gamma; Normal Inverse Gaussian;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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