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

Flavia Barsotti, L. Del Viva*

*Corresponding author for this work

Research output: Indexed journal article Articlepeer-review

1 Citation (Scopus)

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.

Original languageEnglish
Pages (from-to)95-111
Number of pages17
JournalJournal of Banking and Finance
Volume58
DOIs
Publication statusPublished - 1 Sept 2015
Externally publishedYes

Keywords

  • Corporate bond spreads
  • Credit risk
  • Distress
  • Hedge ratios
  • Normal Inverse Gaussian
  • Spread sensitivity
  • Variance Gamma

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