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On the calibration of structural credit spread models

On the calibration of structural credit spread models Empirical findings are mixed about the performance of structural models for term structure of credit spreads. It is commonly believed that all structural models have equally poor performance after calibration. However, proper calibration is not a trivial issue, especially for highly structural models. This paper proposes a more accurate procedure for calibrating two models: Leland–Toft (J Finance 51:987–1019, 1996) and Collin-Dufresne and Goldstein (J Finance 56:2177–2208, 2001). Using rating-based bond data, we find that the Leland–Toft model has significantly greater explanatory power for credit spreads across rating categories than previously reported. We provide theoretical explanations for these findings, and further extend our empirical analysis to include 286 individual senior bonds. Our findings help clarify the controversies over the performance of structural models in general and that of the Leland–Toft model in particular. In addition, we offer a rigorous procedure that can be used for calibrating other structural models more effectively. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Annals of Finance Springer Journals

On the calibration of structural credit spread models

Annals of Finance , Volume 5 (2) – Mar 14, 2008

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References (28)

Publisher
Springer Journals
Copyright
Copyright © 2008 by Springer-Verlag
Subject
Finance; Finance, general; Economic Theory/Quantitative Economics/Mathematical Methods; Quantitative Finance; Macroeconomics/Monetary Economics//Financial Economics
ISSN
1614-2446
eISSN
1614-2454
DOI
10.1007/s10436-008-0097-3
Publisher site
See Article on Publisher Site

Abstract

Empirical findings are mixed about the performance of structural models for term structure of credit spreads. It is commonly believed that all structural models have equally poor performance after calibration. However, proper calibration is not a trivial issue, especially for highly structural models. This paper proposes a more accurate procedure for calibrating two models: Leland–Toft (J Finance 51:987–1019, 1996) and Collin-Dufresne and Goldstein (J Finance 56:2177–2208, 2001). Using rating-based bond data, we find that the Leland–Toft model has significantly greater explanatory power for credit spreads across rating categories than previously reported. We provide theoretical explanations for these findings, and further extend our empirical analysis to include 286 individual senior bonds. Our findings help clarify the controversies over the performance of structural models in general and that of the Leland–Toft model in particular. In addition, we offer a rigorous procedure that can be used for calibrating other structural models more effectively.

Journal

Annals of FinanceSpringer Journals

Published: Mar 14, 2008

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