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An empirical analysis of structural models of corporate debt pricing

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Author Info
Joao C. A. Teixeira (Lancaster University Management School)

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Abstract

This paper tests empirically the performance of three structural models of corporate bond pricing, namely Merton (1974), Leland (1994) and Fan and Sundaresan (2000). While the first two models overestimate bond prices, the Fan and Sundaresan model reveals an extremely good performance. When considering the prediction of credit spreads, the three models under-estimate market spreads but, again, Fan and Sundaresan has a better performance. We find rating, maturity and asset volatility effects in the prediction power, as the models under-estimate less the spreads of riskier firms and of bonds with better rating quality and longer maturity. Moreover, our results reveal the existence of a new industry effect. Spread errors are systematically related to some bond- and firm-specific variables, as well as term structure variables.

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Paper provided by EconWPA in its series Finance with number 0505001.

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Length: 41 pages
Date of creation: 01 May 2005
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Handle: RePEc:wpa:wuwpfi:0505001

Note: Type of Document - pdf; pages: 41
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Related research
Keywords: structural models; corporate debt valuation; empirical credit spreads;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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References listed on IDEAS
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  1. Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(2), pages 499-544. [Downloadable!] (restricted)
  2. Reneby, Joel & Ericsson, Jan, 2001. "The Valuation of Corporate Liabilities: Theory and Tests," Working Paper Series in Economics and Finance 445, Stockholm School of Economics, revised 19 Dec 2002. [Downloadable!]
  3. Franks, Julian R. & Torous, Walter N., 1994. "A comparison of financial recontracting in distressed exchanges and chapter 11 reorganizations," Journal of Financial Economics, Elsevier, vol. 35(3), pages 349-370, June. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
  5. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(1), pages 37-68. [Downloadable!] (restricted)
  6. Giampaolo Gabbi & Andrea Sironi, 2005. "Which factors affect corporate bonds pricing? Empirical evidence from eurobonds primary market spreads," European Journal of Finance, Taylor and Francis Journals, vol. 11(1), pages 59-74, February. [Downloadable!] (restricted)
  7. 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. [Downloadable!] (restricted)
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  8. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
    Other versions:
  9. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-52, September. [Downloadable!] (restricted)
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  10. 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. [Downloadable!] (restricted)
  11. 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. [Downloadable!] (restricted)
  12. 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. [Downloadable!] (restricted)
  13. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June. [Downloadable!] (restricted)
  14. Fan, Hua & Sundaresan, Suresh M, 2000. "Debt Valuation, Renegotiation, and Optimal Dividend Policy," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 13(4), pages 1057-99.
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