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

Author

Listed:
  • Jan Ericsson

    (Desautels Faculty of Management, McGill University, 1001 Sherbrooke Street West, Montreal QC, H3A 1G5, Canada)

  • Joel Reneby
  • Hao Wang

    (School of Economics and Management, Tsinghua University, 318 Weilun Building, Beijing 100084, China)

Abstract

Using a set of structural models, we evaluate the price of default protection for a sample of US corporations. In contrast to previous evidence from corporate bond data, credit default swap (CDS) premia are not systematically underestimated. In fact, one of our studied models has little difficulty on average in predicting their level. For robustness, we perform the same exercise for bond spreads by the same issuers on the same trading date. As expected, bond spreads relative to the treasury curve are systematically underestimated. This is not the case when the swap curve is used as a benchmark, suggesting that previously documented underestimation results may be sensitive to the choice of risk-free rate.

Suggested Citation

  • Jan Ericsson & Joel Reneby & Hao Wang, 2015. "Can Structural Models Price Default Risk? Evidence from Bond and Credit Derivative Markets," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 5(03), pages 1-32, September.
    • Handle: RePEc:wsi:qjfxxx:v:05:y:2015:i:03:n:s201013921550007x
    DOI: 10.1142/S201013921550007X
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    References listed on IDEAS

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    Cited by:

    1. 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.
    2. Song Han & Hao Zhou, 2016. "Effects of Liquidity on the Non-Default Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(03), pages 1-49, September.
    3. Forte, Santiago & Lovreta, Lidija, 2019. "Volatility discovery: Can the CDS market beat the equity options market?," Finance Research Letters, Elsevier, vol. 28(C), pages 107-111.
    4. Forte, Santiago & Lovreta, Lidija, 2023. "Credit default swaps, the leverage effect, and cross-sectional predictability of equity and firm asset volatility," Journal of Corporate Finance, Elsevier, vol. 79(C).
    5. Chen, Guojin & Liu, Yanzhen & Zhang, Yu, 2021. "Systemic risk measures and distribution forecasting of macroeconomic shocks," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 178-196.
    6. Lovreta, Lidija & Silaghi, Florina, 2020. "The surface of implied firm’s asset volatility," Journal of Banking & Finance, Elsevier, vol. 112(C).

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