Structural models of corporate bond pricing

An empirical analysis

Young ho Eom, Jean Helwege, Jing Zhi Huang

Research output: Contribution to journalArticle

297 Citations (Scopus)

Abstract

This article empirically tests five structural models of corporate bond pricing: those of Merton (1974), Geske (1977), Longstaff and Schwartz (1995), Leland and Toft (1996), and Collin-Dufresne and Goldstein (2001). We implement the models using a sample of 182 bond prices from firms with simple capital structures during the period 1986-1997. The conventional wisdom is that structural models do not generate spreads as high as those seen in the bond market, and true to expectations, we find that the predicted spreads in our implementation of the Merton model are too low. However, most of the other structural models predict spreads that are too high on average. Nevertheless, accuracy is a problem, as the newer models tend to severely overstate the credit risk of firms with high leverage or volatility and yet suffer from a spread underprediction problem with safer bonds. The Leland and Toft model is an exception in that it overpredicts spreads on most bonds, particularly those with high coupons. More accurate structural models must avoid features that increase the credit risk on the riskier bonds while scarcely affecting the spreads of the safest bonds.

Original languageEnglish
Pages (from-to)499-544
Number of pages46
JournalReview of Financial Studies
Volume17
Issue number2
DOIs
Publication statusPublished - 2004 Jun 1

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Corporate bonds
Bond pricing
Empirical analysis
Structural model
Credit risk
Bond prices
Bond market
Leverage
Wisdom
Coupons
Merton model
Capital structure

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this

Eom, Young ho ; Helwege, Jean ; Huang, Jing Zhi. / Structural models of corporate bond pricing : An empirical analysis. In: Review of Financial Studies. 2004 ; Vol. 17, No. 2. pp. 499-544.
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Structural models of corporate bond pricing : An empirical analysis. / Eom, Young ho; Helwege, Jean; Huang, Jing Zhi.

In: Review of Financial Studies, Vol. 17, No. 2, 01.06.2004, p. 499-544.

Research output: Contribution to journalArticle

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