Evaluation of conducting capital structure arbitrage using the multi-period extended Geske–Johnson model

Evaluation of conducting capital structure arbitrage using the multi-period extended... This study utilizes a multi-period structural model developed by Chen and Yeh (Pricing credit default swaps with the extended Geske–Johnson Model. Working paper, 2006), which extends the Geske and Johnson (J Financ Quant Anal 19:231–232, 1984) compound option model to evaluate the performance of capital structure arbitrage. In the paper, first of all, we predict the default probability for each firm using the multi-period Geske–Johnson model that assumes endogenous default barriers. Second, based on the arbitrage performance of 369 North American obligators from 2004 to 2008, we find that the extended Geske–Johnson model is more suitable than the CreditGrades model for exploiting the mispricing between equity prices and credit default swap spreads. Finally, the Geske–Johnson model also performs well in extreme market condition, such as the financial crisis around 2008. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Evaluation of conducting capital structure arbitrage using the multi-period extended Geske–Johnson model

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Publisher
Springer US
Copyright
Copyright © 2013 by Springer Science+Business Media New York
Subject
Economics / Management Science; Finance/Investment/Banking; Accounting/Auditing; Econometrics; Operations Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-013-0400-x
Publisher site
See Article on Publisher Site

Abstract

This study utilizes a multi-period structural model developed by Chen and Yeh (Pricing credit default swaps with the extended Geske–Johnson Model. Working paper, 2006), which extends the Geske and Johnson (J Financ Quant Anal 19:231–232, 1984) compound option model to evaluate the performance of capital structure arbitrage. In the paper, first of all, we predict the default probability for each firm using the multi-period Geske–Johnson model that assumes endogenous default barriers. Second, based on the arbitrage performance of 369 North American obligators from 2004 to 2008, we find that the extended Geske–Johnson model is more suitable than the CreditGrades model for exploiting the mispricing between equity prices and credit default swap spreads. Finally, the Geske–Johnson model also performs well in extreme market condition, such as the financial crisis around 2008.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Aug 25, 2013

References

  • Valuing corporate securities: some effects of bond indenture provisions
    Black, F; Cox, JC
  • A bridge from ruin theory to credit risk
    Chen, CJ; Panjer, H
  • Empirical performance of the constant elasticity variance option pricing model
    Chen, RR; Lee, CF; Lee, HH
  • Credit swap valuation
    Duffie, D

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