Relationship between credit spread and IPO price: An anecdotal case study of the Nordic market

Johan Bernhard Christie Berle & Kristin Horn

Student thesis: Master thesis


The purpose of this thesis is to examine the link between bonds and equity, and determine if we can project a fair IPO price through traded debt. We base our thesis on the theory behind the classical Merton model which states that one can price debt by using data from equity, and use this to invert two types of structural models to price equity. With the use of Bloomberg and Stamdata, we collect data of bonds that has been traded prior to the issuer’s IPO. We have only identified seven companies with bonds issued prior to their IPO, which means our analysis is an anecdotal case study, and there is therefore no guarantee that the results we find are representable. From our theoretical analysis, we find that most of the structural models does not have any assumptions that prevent them from being inverted empirically. However we also find that the Black- Cox model cannot be inverted because it allows for bankruptcy at any time, as long as the value drops below a certain point. This is a problem because without equity being traded, there is nothing to protect shareholders from debt holders manipulating the price and taking control of the company. From our statistical analysis we find indications that IPOs have no effect on credit spreads. However our sample is too small to draw any decisive conclusions. We also use statistical analysis to see if there is a relationship between equity and debt. Here we find weaker correlations than we would expect, but graphically we see a clear relationship. After this we have used inverted Merton and Geske models, to calculate IPO prices for the firms in our anecdotal study, and compared them to the actual IPO prices and first day returns to determine how accurate they are. The results from these models are far from the actual prices. This not unexpected because the models are the most basic versions of structural models In this thesis we have created a theoretical framework for pricing IPOs through debt. With our small sample and simple models, we have been unable to deduce if structural models are a viable option for IPO pricing. We hope our findings will help and inspire to further research to find conclusive answers in this area.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2015
Number of pages178