Can Structural Models Price Default Risk? New Evidence From Bond and Credit Derivative Markets

Topics:
Investment and Capital Markets
Tags:
Bond,
Finance,
Investment
Source:
McGill University

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Overview: Using a set of structural models, this paper evaluates bond yield spreads and the price of default protection for a sample of US corporations. Theory predicts that if credit risk alone explains these two quantities, their magnitudes should be similar. The findings concur with previous results that bond yield spreads are underestimated. However, this is not systematically the case for CDS premia, which in the dataset are much lower than bond spreads. Furthermore, these results highlight the strong relationship between bond residuals and non-default proxies, in particular illiquidity. CDS residuals exhibit no such relations.

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Format: PDF | Size: 381KB | Date: Jan 2005 | Pages: 35

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