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Implementing Structural Credit Risk Models Using Both Stock And Bond Prices An Empirical Study
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Book Synopsis Implementing Structural Credit Risk Models Using Both Stock and Bond Prices - an Empirical Study by : Joel Reneby
Download or read book Implementing Structural Credit Risk Models Using Both Stock and Bond Prices - an Empirical Study written by Joel Reneby and published by . This book was released on 2004 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: Reduced form credit risk models are often thought to be better suited for pricing corporate bonds than structural models. In this paper we challenge this view; by conditioning not only on equity but also on bond and dividend information, our structural model performs well in comparison to previously tested reduced form models. Moreover, we consider pricing of bond portfolios and show that model errors are to a large extent diversifiable.
Book Synopsis Structural Models of Corporate Bond Pricing by : Young Ho Eom
Download or read book Structural Models of Corporate Bond Pricing written by Young Ho Eom and published by . This book was released on 2003 with total page 48 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Assessing Default Probabilities from Structural Credit Risk Models by : Wei Wang
Download or read book Assessing Default Probabilities from Structural Credit Risk Models written by Wei Wang and published by . This book was released on 2008 with total page 58 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this paper, we study the empirical performance of structural credit risk models by examining the default probabilities calculated from these models with different time horizons. The parameters of the models are estimated from firm's bond and equity prices. The models studied include Merton (1974), Merton model with stochastic interest rate, Longstaff and Schwartz (1995), Leland and Toft (1996) and Collin-Dufresne and Goldstein (2001). The sample firms chosen are those that have only one bond outstanding when bond prices are observed. We first find that when the Maximum Likelihood estimation, introduced in Duan (1994), is used to estimate the Merton model from bond prices, the estimated volatility is unreasonable high and the estimation process does not converge for most of the firms in our sample. This shows that the Merton (1974) is not able to generate high yields to match the empirical observations. On the other hand, when equity prices are used as input we find that the default probabilities predicted for investment-grade firms by Merton (1974) are all close to zero. When stochastic interest rates are assumed in Merton model, the model performance is improved. The models of Longstaff and Schwartz (1995) with constant interest rate as well as the Leland and Toft (1996) provide quite reasonable predictions on real default probabilities when compared with those reported by Moody's and Samp;P. However, Collin-Dufresnce and Goldstein (2001) predict unreasonably high default probabilities for longer time horizons.
Download or read book Credit Risk written by Niklas Wagner and published by CRC Press. This book was released on 2008-05-28 with total page 600 pages. Available in PDF, EPUB and Kindle. Book excerpt: Featuring contributions from leading international academics and practitioners, Credit Risk: Models, Derivatives, and Management illustrates how a risk management system can be implemented through an understanding of portfolio credit risks, a set of suitable models, and the derivation of reliable empirical results. Divided into six sectio
Book Synopsis Reduced Form vs. Structural Models of Credit Risk by : Navneet Arora
Download or read book Reduced Form vs. Structural Models of Credit Risk written by Navneet Arora and published by . This book was released on 2005 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: In this paper, we empirically compare two structural models (basic Merton and Vasicek-Kealhofer (VK)) and one reduced-form model (Hull-White (HW)) of credit risk. We propose here that two useful purposes for credit models are default discrimination and relative value analysis. We test the ability of the Merton and VK models to discriminate defaulters from non-defaulters based on default probabilities generated from information in the equity market. We test the ability of the HW model to discriminate defaulters from non-defaulters based on default probabilities generated from information in the bond market. We find the VK and the HW models exhibit comparable accuracy ratios as well as substantially outperform the simple Merton model. We also test the ability of each model to predict spreads in the credit default swap (CDS) market as an indication of each model's strength as a relative value analysis tool. We find the VK model tends to do the best across the full sample and relative sub-samples except for cases where an issuer has many bonds in the market. In this case, the HW model tends to do the best. The empirical evidence will assist market participants in determining which model is most useful based on their purpose in hand. On the structural side, a basic Merton model is not good enough; appropriate modifications to the framework make a difference. On the reduced-form side, the quality and quantity of data make a difference; many traded issuers will not be well modeled in this way unless they issue more traded debt. In addition, bond spreads at shorter tenors (less than two years) tend to be less correlated with CDS spreads. This makes accurate calibration of the term-structure of credit risk difficult from bond data.
Book Synopsis Structural Models of Corporate Bond Pricing with Maximum Likelihood Estimation by : Ka Leung Li
Download or read book Structural Models of Corporate Bond Pricing with Maximum Likelihood Estimation written by Ka Leung Li and published by . This book was released on 2009 with total page 51 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper empirically examines the proxy, volatility-restriction (VR) and maximum likelihood (ML) approaches to implementing structural corporate bond pricing models, and documents that ML estimation is the best among the three implementation methods. Empirical studies using either the proxy approach or the VR method conclude that barrier-independent models significantly underestimate corporate bond yields. Although barrier-dependent models tend to overestimate the yield on average, they generate a sizable degree of underestimation. The present paper shows that the proxy approach is an upwardly biased estimator of the corporate assets and makes the empirical framework work systematically against structural models of corporate bond pricing. The VR approach may generate inconsistent corporate bond prices or may fail to give a positive corporate bond price for some structural models. When the Merton, LS, BD and LT models are implemented with ML estimation, we find substantial improvement in their performances. Our empirical analysis shows that the LT model is very accurate for predicting short-term bond yields, whereas the LS and BD models are good predictors for medium-term and long-term bonds. The Merton model however significantly overestimates short-term bond yields and underestimates long-term bond yields. Unlike empirical studies in the past, the Merton model implemented with ML estimation does not consistently underestimate corporate bond yields.
Book Synopsis Does Modeling Framework Matter? A Comparative Study of Structural and Reduced-Form Models by : Yalin Gündüz
Download or read book Does Modeling Framework Matter? A Comparative Study of Structural and Reduced-Form Models written by Yalin Gündüz and published by . This book was released on 2015 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: This study provides a rigorous empirical comparison of structural and reduced-form credit risk frameworks. The literature differentiates between structural models that are based on modeling of the evolution of the balance sheet of the issuer, and reduced-form models that specify credit risk exogenously by a hazard rate process. Until now, there has been no common agreement in academia and practice on which model framework better captures credit risk. As major difference we focus on the discriminative modeling of the default time. In contrast to the previous literature, we calibrate both approaches to the same data set, apply comparable estimation techniques, and assess the out-of-sample prediction quality on the same time series of CDS prices. As our empirical implementations of both approaches rely on the same market information we are able to judge whether empirically the model structure itself makes an important difference. Interestingly, our study shows that the models' prediction power are quite close on average indicating that for pricing purposes the modeling type does not greatly matter compared to the input data used. Still, the reduced-form approach outperforms the structural for investment-grade names and longer maturities. In contrast the structural approach performs better for shorter maturities and sub-investment grade names.
Book Synopsis Empirical Asset Pricing by : Wayne Ferson
Download or read book Empirical Asset Pricing written by Wayne Ferson and published by MIT Press. This book was released on 2019-03-12 with total page 497 pages. Available in PDF, EPUB and Kindle. Book excerpt: An introduction to the theory and methods of empirical asset pricing, integrating classical foundations with recent developments. This book offers a comprehensive advanced introduction to asset pricing, the study of models for the prices and returns of various securities. The focus is empirical, emphasizing how the models relate to the data. The book offers a uniquely integrated treatment, combining classical foundations with more recent developments in the literature and relating some of the material to applications in investment management. It covers the theory of empirical asset pricing, the main empirical methods, and a range of applied topics. The book introduces the theory of empirical asset pricing through three main paradigms: mean variance analysis, stochastic discount factors, and beta pricing models. It describes empirical methods, beginning with the generalized method of moments (GMM) and viewing other methods as special cases of GMM; offers a comprehensive review of fund performance evaluation; and presents selected applied topics, including a substantial chapter on predictability in asset markets that covers predicting the level of returns, volatility and higher moments, and predicting cross-sectional differences in returns. Other chapters cover production-based asset pricing, long-run risk models, the Campbell-Shiller approximation, the debate on covariance versus characteristics, and the relation of volatility to the cross-section of stock returns. An extensive reference section captures the current state of the field. The book is intended for use by graduate students in finance and economics; it can also serve as a reference for professionals.
Book Synopsis Calibration of Structural Credit Risk Models by : Søren Willemann
Download or read book Calibration of Structural Credit Risk Models written by Søren Willemann and published by . This book was released on 2004 with total page 38 pages. Available in PDF, EPUB and Kindle. Book excerpt: Empirical tests of structural credit risk models typically ignore bond prices when estimating parameters. In this paper we depart from this, examining a calibration of the Collin-Dufresne amp; Goldstein (2001) model to bond prices. Using alternative specifications of a liquidity discount we evaluate the model based on fit to yield spreads and sensitivities to underlying fundamentals, producing a novel approach to evaluating the fit of a credit risk model. When augmenting with a liquidity discount we obtain a very good fit and outperform a two-factor reduced form model. Generally we understate the sensitivity towards changes in the leverage ratio and to a larger degree changes in the short interest rate. For investment grade bonds the model attributes 40% of the yield spread at 5 years of maturity to credit risk, in some agreement with the literature.
Book Synopsis Investigating the Sources of Default Risk by : Gurdip Bakshi
Download or read book Investigating the Sources of Default Risk written by Gurdip Bakshi and published by . This book was released on 2001 with total page 66 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis A Simple Multi-Factor Model of Corporate Bond Prices by : Clemens Mueller
Download or read book A Simple Multi-Factor Model of Corporate Bond Prices written by Clemens Mueller and published by . This book was released on 2001 with total page 79 pages. Available in PDF, EPUB and Kindle. Book excerpt: We propose a multi-factor structural model of corporate bond prices. Bonds are valued in an arbitrage-free setting. The term structure of credit spreads is a function of a set of observable variables, including the issuer's leverage ratio, the riskfree interest rate and other stochastic factors that proxy for the issuer's likelihood of default. The set of factors may include both systematic and idiosyncratic components. We test the model using prices of Delta Airlines' bonds. Factors included in this empirical analysis are the growth rate of GDP and the volatility on Delta's stock. The root mean squared error between actual credit spreads and model-determined credit spreads decreases from 45 to 40 basis points when these factors are included in the analysis. Several extant models in the literature are special cases of the structure developed here and rejected in the empirical work.
Book Synopsis Specification Analysis of Structural Credit Risk Models by : Jing-Zhi Huang
Download or read book Specification Analysis of Structural Credit Risk Models written by Jing-Zhi Huang and published by . This book was released on 2019 with total page 61 pages. Available in PDF, EPUB and Kindle. Book excerpt: Empirical studies of structural credit risk models so far are often based on calibration, rolling estimation, or regressions. This paper proposes a GMM-based method that allows us to both consistently estimate the model parameters and test whether all the restrictions of the model are satisfied. We conduct a specification analysis of five representative structural models based on the proposed GMM procedure, using information from both equity volatility and term structures of single-name credit default swap (CDS) spreads. Our test results strongly reject the Merton (1974) model and two diffusion-based models with a constant default boundary. The other two models, one with jumps and one with stationary leverage ratios, do improve the overall fit of CDS spreads and equity volatility. However, all five models have difficulty capturing the dynamic behavior of both equity volatility and CDS spreads, especially for investment-grade names. On the other hand, these models have a much better ability to explain the sensitivity of CDS spreads to equity returns.
Book Synopsis Structural Models of Credit Risk are Useful by : Ilya A. Strebulaev
Download or read book Structural Models of Credit Risk are Useful written by Ilya A. Strebulaev and published by . This book was released on 2007 with total page 50 pages. Available in PDF, EPUB and Kindle. Book excerpt: It is well known that structural models of credit risk provide poor predictions of bond prices. We show that they may perform much better as a predictor of debt return sensitivities to equity. This is important since it gives us an opportunity to identify much better the reasons for model failure. The main result of this paper is that even the simplest of the structural models (Merton (1974)) produces hedge ratios that are in line with those observed empirically. As well as providing insight into the determinants of corporate bond prices our results are also useful to practitioners who wish to hedge their positions in corporate debt. The paper also shows that corporate bond prices are sensitive to some variables - e.g., VIX - in a way that appears unrelated to credit risk.
Book Synopsis Modelling Default-risky Bonds by : Frank Mashoko Magwegwe
Download or read book Modelling Default-risky Bonds written by Frank Mashoko Magwegwe and published by . This book was released on 2013 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: In this dissertation, we examine current models used to value default-risky bonds. These models include both the structural and the reduced-form approaches. We begin by examining various issues involved in modelling credit risk and pricing credit derivatives. We then explore the various dimensions of structural models and reduced-form models and we provide an overview of four models presented in the literature on credit risk modelling. Both the theoretical and empirical research on default-risky bond valuation is summarized. Finally, we make suggestions for improving on the credit risk models discussed.
Book Synopsis Estimating Jump Diffusion Structural Credit Risk Models by : Hoi Ying Wong
Download or read book Estimating Jump Diffusion Structural Credit Risk Models written by Hoi Ying Wong and published by . This book was released on 2006 with total page 43 pages. Available in PDF, EPUB and Kindle. Book excerpt: There is strong evidence that structural models of credit risk significantly underestimate both credit yield spreads and the probability of default if the value of corporate assets follows a diffusion process. Adding a jump component to the firm value process is a potential remedy for the underestimation. However, there are very few empirical studies of jump-diffusion (or Levy) structural models in the literature. The major challenge is the estimation of hidden variables, such as the firm value, volatility, and parameters of the jump component, as the value of corporate assets is not directly observable. In practice, parameters and the value of the firm should be estimated using the market values of equities. This paper provides a promising estimation method for jump-diffusion processes in structural models that are based on observed stock data. We show that the traditional estimation methods for structural models, the variance-restriction method and maximum likelihood estimation, fail when jumps appear in credit risk models. We then propose a penalized likelihood approach and devise a corresponding expectationmaximum algorithm. The approach is applied to the jump-diffusion processes of Merton (1976) and Kou (2002) and the performance is examined through a series of simulations and empirical data.
Book Synopsis An Empirical Analysis of Structural Models of Corporate Debt Pricing by : João C. A. Teixeira
Download or read book An Empirical Analysis of Structural Models of Corporate Debt Pricing written by João C. A. Teixeira and published by . This book was released on 2005 with total page 43 pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.
Book Synopsis Contingent Convertible ('CoCo') Bonds by : Sascha Wilkens
Download or read book Contingent Convertible ('CoCo') Bonds written by Sascha Wilkens and published by . This book was released on 2014 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: With several banks issuing substantial amounts of contingent convertible (“coco”) bonds since 2009 this paper is the first to analyse empirically the suitability of selected pricing models that have been proposed for this kind of instrument. The analysis of coco bond issues by major banks shows that all tested approaches - a structural, an equity derivatives and a credit derivatives model - are largely able to fit observed coco bond prices. Regarding the derivation of hedge ratios, however, all models are found to exhibit biases. Overall, the results point to the equity derivatives model with its straightforward parameterisation and interpretation as the comparatively most promising approach for the practical pricing and risk management of coco bonds. Given the limited set of bonds and time series available for the analysis, more empirical research into the still young market is required.
