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An empirical analysis of structural models of corporate debt pricing

  • Joao Teixeira

This article 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 exhibits an impressively good performance. When considering the prediction of credit spreads, the three models underestimate market spreads but, again, Fan and Sundaresan performs better. We find rating, maturity and asset volatility effects in the prediction power, as the models underestimate 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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File URL: http://www.tandfonline.com/doi/abs/10.1080/09603100600770994
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Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 17 (2007)
Issue (Month): 14 ()
Pages: 1141-1165

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Handle: RePEc:taf:apfiec:v:17:y:2007:i:14:p:1141-1165
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  1. 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.
  2. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June.
  3. 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.
  4. 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.
  5. 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.
  6. Fan, Hua & Sundaresan, Suresh M, 2000. "Debt Valuation, Renegotiation, and Optimal Dividend Policy," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1057-99.
  7. 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.
  8. 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.
  9. Hayne E. Leland and Klaus Bjerre Toft., 1995. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Research Program in Finance Working Papers RPF-259, University of California at Berkeley.
  10. 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.
  11. 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.
  12. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, 04.
  13. Giampaolo Gabbi & Andrea Sironi, 2005. "Which factors affect corporate bonds pricing? Empirical evidence from eurobonds primary market spreads," The European Journal of Finance, Taylor & Francis Journals, vol. 11(1), pages 59-74.
  14. 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.
  15. Reneby, Joel & Ericsson, Jan, 2001. "The Valuation of Corporate Liabilities: Theory and Tests," SSE/EFI Working Paper Series in Economics and Finance 445, Stockholm School of Economics, revised 19 Dec 2002.
  16. 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.
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