Extracting Credit Spreads from Structural Models Via the Payout Ratio

54 Pages Posted: 2 Jul 2013

Date Written: July 1, 2013

Abstract

I introduce a new way to imply credit spreads from structural models. The proposed measure, CS_POR, is extracted via the payout ratio as the increase in continuous interest payments to creditors necessary to offset the impact of an increase in asset variance on the option value of debt. I derive CS_POR for the Merton (1974) model of capital structure and use it in an empirical setting to explain variations in the spreads of (i) corporate bonds and (ii) credit default swaps. My measure clearly outperforms its benchmark and even beats predictors from a powerful reduced-form model.

Keywords: Credit Risk, Structural Model, Bond Spread, Credit Default Swap

JEL Classification: G12, G13

Suggested Citation

Grass, Gunnar, Extracting Credit Spreads from Structural Models Via the Payout Ratio (July 1, 2013). Available at SSRN: https://ssrn.com/abstract=2288086 or http://dx.doi.org/10.2139/ssrn.2288086

Gunnar Grass (Contact Author)

HEC Montréal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H3T2A7
Canada
5143401540 (Phone)

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