Empirical Research on Structural Models and their Performance in Pricing CDS Spreads

Andrea Zennaro

Studenteropgave: Kandidatafhandlinger

Abstrakt

The aim of this dissertation is to inquire on the performance of structural models in the European debt market. Merton model is the pioneer among this class of models. Despite its simplicity and intuitiveness, it is affected by several limits which have been addressed by subsequent extensions. We implemented the original Merton model, as well as three subsequent extensions, to price synthetic CDS spreads and compare the results with market prices. We chose to base our analysis on CDS spreads because they are a cleaner measure of credit risk and, thus, they are less affected by non-credit risk factors. Results provided a strong evidence that, on average, structural models underpredict market CDS spreads. This result is emphasized for investment grade companies but it is present, in a smaller magnitude, also for sub-investment grade companies. Notwithstanding its limits, Merton model appears to be the best model among those tested. In addition, we conducted an analysis based on subsample sorted by sector and nationality. On the one hand, the analysis by sector provides evidences of the good performance of structural model on Basic Material, Consumer and Industrial sectors but not for financial sector. On the other hand, the analysis by nationality gives mixed results affected by the low number of observations and sector concentration for some countries.

UddannelserCand.merc.aef Applied Economics and Finance, (Kandidatuddannelse) Afsluttende afhandling
SprogEngelsk
Udgivelsesdato2015
Antal sider77