Calibrating structural models: A new methodology based on stock and credit default swap data

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14 Citations (Scopus)

Abstract

This paper presents a modified version of Leland and Toft's [J. Finance, 1996, 51, 987-1019] structural credit risk model, together with a novel calibration methodology based on stock and CDS data: the firm asset value and volatility are consistently derived from equity prices; the default barrier is calibrated from CDS premia. It empirically shows that as long as the appropriate default barrier is selected, the model generates time series of stock market implied credit spreads that fit the times series of CDS spreads. Moreover, CDS implied default barriers prove to be consistent with stockholders' rationality, with predictions made by structural models with endogenous default, and with historical recovery rates.

Original languageEnglish
Pages (from-to)1745-1759
Number of pages15
JournalQuantitative Finance
Volume11
Issue number12
DOIs
Publication statusPublished - Dec 2011
Externally publishedYes

Keywords

  • Calibration
  • Default barrier
  • Structural credit risk models

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