A Comparative Study of Structural Models of Corporate Bond Yields: An Exploratory Investigation
AbstractThis paper empirically compares a variety of firm-value-based models of contingent claims. We formulate a general model which takes the perpetual coupon bond models of Merton (1974), Leland (1994) and Anderson, Sundaresan and Tychon (1996), as well as some immediate generalizations thereof, as special cases. We estimate these using aggregate time series data for the US corporate bond market, monthly, from August 1970 through December 1996. The data are average yields for industrial corporate bonds rated BBB, Treasury yields, leverage measures derived from the Flow of Funds Accounts, interest coverage measures derived from the National Income Accounts, and volatility measures derived from the stock market. In the basic specification with constant default free rates, we find that models with endogenous bankruptcy barriers (the Leland and the Anderson, Sundaresan and Tychon models) fit quite well. Thus, in these models, variations of leverage and asset volatility are found to account for much of the time-series variations of observed corporate yields. We then use the estimates to calculate the implied probability of default within N years. We find under plausible assumptions on the market risk-premium for levered firms that the models produce default probabilities for 5 years or more which are in line with the historical experience reported by Moodys.
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Bibliographic InfoPaper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 1999009.
Date of creation: 01 Jul 1998
Date of revision: 00 Jan 1999
Contingent Claims Analysis; Corporate Bonds; Credit Risk;
Find related papers by 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
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
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- Benjamin M. Friedman, 1985. "Corporate Capital Structures in the United States," NBER Books, National Bureau of Economic Research, Inc, number frie85-1, October.
- Chen, Nai-Fu, 1991. " Financial Investment Opportunities and the Macroeconomy," Journal of Finance, American Finance Association, vol. 46(2), pages 529-54, June.
- Merton, Robert C., 1973.
"On the pricing of corporate debt: the risk structure of interest rates,"
684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
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