IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v58y2015icp95-111.html
   My bibliography  Save this article

Performance and determinants of the Merton structural model: Evidence from hedging coefficients

Author

Listed:
  • Barsotti, Flavia
  • Viva, Luca Del

Abstract

We empirically test the effectiveness of the Merton (1974) model in measuring the sensitivity of corporate bond returns to changes in equity value. We study the main variables that affect the performance of the model and relax the assumption of normally distributed rates of return. Results show that less than 6% of the bonds have a hedge ratio within 10% from the model predicted value. Volatility, time to maturity, size, distress, liquidity and information quality are found to be significant determinants of the efficacy of the model.

Suggested Citation

  • Barsotti, Flavia & Viva, Luca Del, 2015. "Performance and determinants of the Merton structural model: Evidence from hedging coefficients," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 95-111.
    • Handle: RePEc:eee:jbfina:v:58:y:2015:i:c:p:95-111
    DOI: 10.1016/j.jbankfin.2015.04.007
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426615000837
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jbankfin.2015.04.007?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Dilip B. Madan & Peter P. Carr & Eric C. Chang, 1998. "The Variance Gamma Process and Option Pricing," Review of Finance, European Finance Association, vol. 2(1), pages 79-105.
    2. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    3. P. Hartmann & S. Straetmans & C. G. de Vries, 2004. "Asset Market Linkages in Crisis Periods," The Review of Economics and Statistics, MIT Press, vol. 86(1), pages 313-326, February.
    4. 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 611-625, July.
    5. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
    6. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    7. Fleming, Jeff & Kirby, Chris & Ostdiek, Barbara, 1998. "Information and volatility linkages in the stock, bond, and money markets," Journal of Financial Economics, Elsevier, vol. 49(1), pages 111-137, July.
    8. Connolly, Robert & Stivers, Chris & Sun, Licheng, 2005. "Stock Market Uncertainty and the Stock-Bond Return Relation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(1), pages 161-194, March.
    9. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    10. 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.
    11. Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," The Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 499-544.
    12. 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.
    13. Lesmond, David A & Ogden, Joseph P & Trzcinka, Charles A, 1999. "A New Estimate of Transaction Costs," The Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 1113-1141.
    14. Madan, Dilip B & Seneta, Eugene, 1990. "The Variance Gamma (V.G.) Model for Share Market Returns," The Journal of Business, University of Chicago Press, vol. 63(4), pages 511-524, October.
    15. Richard Finlay & Eugene Seneta, 2008. "Stationary‐Increment Variance‐Gamma and t Models: Simulation and Parameter Estimation," International Statistical Review, International Statistical Institute, vol. 76(2), pages 167-186, August.
    16. 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 449-470, May.
    17. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    18. Edwin J. Elton & Martin J. Gruber & Deepak Agrawal & Christopher Mann, 2001. "Explaining the Rate Spread on Corporate Bonds," Journal of Finance, American Finance Association, vol. 56(1), pages 247-277, February.
    19. Ivashina, Victoria, 2009. "Asymmetric information effects on loan spreads," Journal of Financial Economics, Elsevier, vol. 92(2), pages 300-319, May.
    20. Pierre Collin-Dufresn & Robert S. Goldstein & J. Spencer Martin, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
    21. Kee‐Hong Bae & Vidhan K. Goyal, 2009. "Creditor Rights, Enforcement, and Bank Loans," Journal of Finance, American Finance Association, vol. 64(2), pages 823-860, April.
    22. 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 351-367, May.
    23. Bao, Jack & Pan, Jun, 2010. "Excess Volatility of Corporate Bonds," Working Paper Series 2010-20, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    24. 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.
    25. Lu, Chia-Wu & Chen, Tsung-Kang & Liao, Hsien-Hsing, 2010. "Information uncertainty, information asymmetry and corporate bond yield spreads," Journal of Banking & Finance, Elsevier, vol. 34(9), pages 2265-2279, September.
    26. 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 637-654, May-June.
    27. Long Chen & David A. Lesmond & Jason Wei, 2007. "Corporate Yield Spreads and Bond Liquidity," Journal of Finance, American Finance Association, vol. 62(1), pages 119-149, February.
    28. Anderson, Ronald & Sundaresan, Suresh, 2000. "A comparative study of structural models of corporate bond yields: An exploratory investigation," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 255-269, January.
    29. Qi, Howard & Liu, Sheen & Wu, Chunchi, 2010. "Structural models of corporate bond pricing with personal taxes," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1700-1718, July.
    30. Tarun Chordia, 2005. "An Empirical Analysis of Stock and Bond Market Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 85-129.
    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


    Cited by:

    1. Liang, Jin & Zhao, Yuejuan & Zhang, Xudan, 2016. "Utility indifference valuation of corporate bond with credit rating migration by structure approach," Economic Modelling, Elsevier, vol. 54(C), pages 339-346.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Goldstein, Michael A. & Namin, Elmira Shekari, 2023. "Corporate bond liquidity and yield spreads: A review," Research in International Business and Finance, Elsevier, vol. 65(C).
    2. Stephanie Heck, 2022. "Corporate bond yields and returns: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 36(2), pages 179-201, June.
    3. Nakashima, Kiyotaka & Saito, Makoto, 2009. "Credit spreads on corporate bonds and the macroeconomy in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 23(3), pages 309-331, September.
    4. Zhou, Xinghua & Reesor, R. Mark, 2015. "Misrepresentation and capital structure: Quantifying the impact on corporate debt value," Journal of Corporate Finance, Elsevier, vol. 34(C), pages 293-310.
    5. repec:wyi:journl:002109 is not listed on IDEAS
    6. Ericsson, Jan & Jacobs, Kris & Oviedo, Rodolfo, 2009. "The Determinants of Credit Default Swap Premia," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 109-132, February.
    7. Yalin Gündüz & Marliese Uhrig-Homburg, 2014. "Does modeling framework matter? A comparative study of structural and reduced-form models," Review of Derivatives Research, Springer, vol. 17(1), pages 39-78, April.
    8. Kapadia, Nikunj & Pu, Xiaoling, 2012. "Limited arbitrage between equity and credit markets," Journal of Financial Economics, Elsevier, vol. 105(3), pages 542-564.
    9. Gregory Connor & Lisa R. Goldberg & Robert A. Korajczyk, 2010. "Portfolio Risk Analysis," Economics Books, Princeton University Press, edition 1, number 9224.
    10. Specht, Leon, 2023. "An Empirical Analysis of European Credit Default Swap Spread Dynamics," Junior Management Science (JUMS), Junior Management Science e. V., vol. 8(1), pages 1-42.
    11. Zhijian (James) Huang & Yuchen Luo, 2016. "Revisiting Structural Modeling of Credit Risk—Evidence from the Credit Default Swap (CDS) Market," JRFM, MDPI, vol. 9(2), pages 1-20, May.
    12. Giesecke, Kay & Longstaff, Francis A. & Schaefer, Stephen & Strebulaev, Ilya, 2011. "Corporate bond default risk: A 150-year perspective," Journal of Financial Economics, Elsevier, vol. 102(2), pages 233-250.
    13. Avino, Davide & Nneji, Ogonna, 2014. "Are CDS spreads predictable? An analysis of linear and non-linear forecasting models," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 262-274.
    14. van Landschoot, A., 2003. "The Term Structure of Credit Spreads on Euro Corporate Bonds," Other publications TiSEM f5164bb2-6597-48c4-8b44-d, Tilburg University, School of Economics and Management.
    15. Jing-Zhi Huang & Zhan Shi & Hao Zhou, 2020. "Specification Analysis of Structural Credit Risk Models [Corporate bond valuation and hedging with stochastic interest rates and endogenous bankruptcy]," Review of Finance, European Finance Association, vol. 24(1), pages 45-98.
    16. van Landschoot, A., 2003. "The Term Structure of Credit Spreads on Euro Corporate Bonds," Discussion Paper 2003-046, Tilburg University, Center for Economic Research.
    17. Abudy, Menachem Meni & Raviv, Alon, 2016. "How much can illiquidity affect corporate debt yield spread?," Journal of Financial Stability, Elsevier, vol. 25(C), pages 58-69.
    18. Forte, Santiago, 2006. "Credit spreads: theory and evidence about the information content of stocks, bonds and cdss," DEE - Working Papers. Business Economics. WB wb063310, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    19. Han-Hsing Lee, 2020. "Distress risk, product market competition, and corporate bond yield spreads," Review of Quantitative Finance and Accounting, Springer, vol. 55(3), pages 1093-1135, October.
    20. Jing-Zhi Huang & Bibo Liu & Zhan Shi, 2023. "Determinants of Short-Term Corporate Yield Spreads: Evidence from the Commercial Paper Market," Review of Finance, European Finance Association, vol. 27(2), pages 539-579.
    21. Murphy, Austin & Headley, Adrian, 2022. "An empirical evaluation of alternative fundamental models of credit spreads," International Review of Financial Analysis, Elsevier, vol. 81(C).

    More about this item

    Keywords

    Credit risk; Hedge ratios; Corporate bond spreads; Spread sensitivity; Distress; Variance Gamma; Normal Inverse Gaussian;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:58:y:2015:i:c:p:95-111. See general information about how to correct material in RePEc.

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.