Advanced Search
MyIDEAS: Login

Specification analysis of structural credit risk models

Contents:

Author Info

  • Jing-zhi Huang
  • Hao Zhou
Registered author(s):

Abstract

In this paper we conduct a specification analysis of structural credit risk models, using term structure of credit default swap (CDS) spreads and equity volatility from high-frequency return data. Our study provides consistent econometric estimation of the pricing model parameters and specification tests based on the joint behavior of time-series asset dynamics and cross-sectional pricing errors. Our empirical tests reject strongly the standard Merton (1974) model, the Black and Cox (1976) barrier model, and the Longstaff and Schwartz (1995) model with stochastic interest rates. The double exponential jump-diffusion barrier model (Huang and Huang, 2003) improves significantly over the three models. The best model is the stationary leverage model of Collin-Dufresne and Goldstein (2001), which we cannot reject in more than half of our sample firms. However, our empirical results document the inability of the existing structural models to capture the dynamic behavior of CDS spreads and equity volatility, especially for investment grade names. This points to a potential role of time-varying asset volatility, a feature that is missing in the standard structural models.

Download Info

If 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.
File URL: http://www.federalreserve.gov/pubs/feds/2008/200855/200855abs.html
Download Restriction: no

File URL: http://www.federalreserve.gov/pubs/feds/2008/200855/200855pap.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2008-55.

as in new window
Length:
Date of creation: 2008
Date of revision:
Handle: RePEc:fip:fedgfe:2008-55

Contact details of provider:
Postal: 20th Street and Constitution Avenue, NW, Washington, DC 20551
Web page: http://www.federalreserve.gov/
More information through EDIRC

Order Information:
Web: http://www.federalreserve.gov/pubs/feds/fedsorder.html

Related research

Keywords: Econometric models ; Risk management;

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Jan Ericsson & Kris Jacobs & Rodolfo A. Oviedo, 2004. "The Determinants of Credit Default Swap Premia," CIRANO Working Papers 2004s-55, CIRANO.
  2. Jan Ericsson, 2005. "Estimating Structural Bond Pricing Models," The Journal of Business, University of Chicago Press, vol. 78(2), pages 707-735, March.
  3. Meddahi, N., 2001. "A Theoretical Comparison Between Integrated and Realized Volatilies," Cahiers de recherche 2001-26, Centre interuniversitaire de recherche en ├ęconomie quantitative, CIREQ.
  4. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  5. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
  6. Ole E. Barndorff-Nielsen, 2004. "Power and Bipower Variation with Stochastic Volatility and Jumps," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 2(1), pages 1-37.
  7. Houweling, Patrick & Vorst, Ton, 2005. "Pricing default swaps: Empirical evidence," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1200-1225, December.
  8. Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
  9. Acharya, Viral V & Carpenter, Jennifer, 2002. "Corporate Bond Valuation and Hedging with Stochastic Interest Rates and Endogenous Bankruptcy," CEPR Discussion Papers 3328, C.E.P.R. Discussion Papers.
  10. 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.
  11. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
  12. Martijn Cremers & Joost Driessen & Pascal Maenhout & David Weinbaum, 2005. "Explaining the level of credit spreads: option-implied jump risk premia in a firm value model," BIS Working Papers 191, Bank for International Settlements.
  13. Pierre Collin-Dufresne, 2001. "Do Credit Spreads Reflect Stationary Leverage Ratios?," Journal of Finance, American Finance Association, vol. 56(5), pages 1929-1957, October.
  14. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  15. Andersen, Torben G & Bollerslev, Tim, 1998. "Answering the Skeptics: Yes, Standard Volatility Models Do Provide Accurate Forecasts," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 885-905, November.
  16. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-25, July.
  17. 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.
  18. Delianedis, Gordon & Geske, Robert, 2001. "The Components of Corporate Credit Spreads: Default, Recovery, Tax, Jumps, Liquidity, and Market Factors," University of California at Los Angeles, Anderson Graduate School of Management qt32x284q3, Anderson Graduate School of Management, UCLA.
  19. John Y. Campbell & Glen B. Taksler, 2002. "Equity Volatility and Corporate Bond Yields," NBER Working Papers 8961, National Bureau of Economic Research, Inc.
  20. 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.
  21. Neil Shephard & Ole E. Barndorff-Nielsen, 2002. "Estimating quadratic variation using realised variance," Economics Series Working Papers 2001-W20, University of Oxford, Department of Economics.
  22. Schaefer, Stephen M. & Strebulaev, Ilya A., 2008. "Structural models of credit risk are useful: Evidence from hedge ratios on corporate bonds," Journal of Financial Economics, Elsevier, vol. 90(1), pages 1-19, October.
  23. Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers RPF-278, University of California at Berkeley.
  24. Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 499-544.
  25. Neil Shephard & Ole E. Barndorff-Nielsen, 2003. "Power and bipower variation with stochastic volatility and jumps," Economics Series Working Papers 2003-W18, University of Oxford, Department of Economics.
  26. Tauchen, George, 1986. "Statistical Properties of Generalized Method-of-Moments Estimators of Structural Parameters Obtained from Financial Market Data," Journal of Business & Economic Statistics, American Statistical Association, vol. 4(4), pages 397-416, October.
  27. Haibin Zhu & Benjamin Yibin Zhang & Hao Zhou, 2005. "Explaining credit default swap spreads with equity volatility and jump risks of individual firms," BIS Working Papers 181, Bank for International Settlements.
  28. Jin-Chuan Duan, 1994. "Maximum Likelihood Estimation Using Price Data Of The Derivative Contract," Mathematical Finance, Wiley Blackwell, vol. 4(2), pages 155-167.
  29. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-64, May.
  30. Fisher, Lawrence, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 625-27, July.
  31. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  32. Geske, Robert, 1977. "The Valuation of Corporate Liabilities as Compound Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 541-552, November.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Song Han & Hao Zhou, 2008. "Effects of liquidity on the nondefault component of corporate yield spreads: evidence from intraday transactions data," Finance and Economics Discussion Series 2008-40, Board of Governors of the Federal Reserve System (U.S.).
  2. Kucuk, Ugur N., 2010. "Non-default Component of Sovereign Emerging Market Yield Spreads and its Determinants: Evidence from Credit Default Swap Market," MPRA Paper 27428, University Library of Munich, Germany.
  3. NUCU, Anca Elena, 2011. "Managementul riscului de creditare: realizari actuale, analiza critica, sugestii
    [Credit risk management: current achievements, critical analysis, suggestions]
    ," MPRA Paper 27932, University Library of Munich, Germany.
  4. Monica Dudian & Monica Balcan Maciuca, 2010. "Internal Ratings Systems: An Empirical Approach," Studies in Business and Economics, Lucian Blaga University of Sibiu, Faculty of Economic Sciences, vol. 5(1), pages 71-79, april.
  5. Scheicher, Martin & Raunig, Burkhard, 2008. "A value at risk analysis of credit default swaps," Discussion Paper Series 2: Banking and Financial Studies 2008,12, Deutsche Bundesbank, Research Centre.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:fip:fedgfe:2008-55. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kris Vajs).

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.