A Comparative Study of Structural Models of Corporate Bond Yields

Introduction

A Comparative Study of Structural Models of Corporate Bond Yields matches a variety of firm value-centred-models of dependent claims (Anderson & Sundaresan 2000). The article conveys an overall model that captures varieties of classical prototypes.Below are the research questions utilized by Anderson & Sundaresan:

1. What is the approximation of structural models of corporate bond yields in the American investment grade corporate bonds?
2. How are variations in yields illustrated?

Even though the research questions exist, they were not clearly presented because they had been integrated into the introduction section.

Literature including theoretical framework and previous empirical evidence

To enhance the reliability of their article, Anderson & Sundaresan utilised scholarly articles. The literatures offered the researchers with theoretical framework and previous empirical evidences (Anderson & Sundaresan 2000). Through this, the researchers were able to illustrate a variety of classical prototypes.

Hypotheses

Anderson and Sundaresan’s hypotheses stated that firm-value-based based models are dependent on a single variable V. V represents the cost of the firm. Anderson and Sundaresanin noted that the null hypothesis or the models fitted perfectly well.

Data

The data utilized in the article were collected from the American financial institutions. The institutions offered the researchers with approximated collective time figures for the American corporate bond market. The figures were collected between the years 1970 and 1996.

Methodology

To assess the models and offer a basis for evaluation, a methodology comprising of a comprehensive framework is utilised. The above led to closed form explanations with the instance of continuous voucher bonds that nests the typical prototype of Merton and modern contributions.

Findings

Generally, the findings are impartially promising for the forecasts of firm valued centred structural prototypes for the valuing of corporate bonds. A number of the movements illustrated in the past time sequences of yields on general corporate bonds were captured in structural prototypes with the help of proxies. It was also noted that the operation of the new prototypes that integrate endogenous insolvency hurdles is slightly higher compared to the original Merton prototype.

Limitation and future research

Like any other research, A Comparative Study of Structural Models of Corporate Bond Yields encountered a number of challenges (Antolin & Blommestein 2007). As such, few studies have been conducted on the topic. Therefore, the investigators had to rely on the limited literature review in their studies. Despite the challenges, I noted that the paper was good and provided crucial information. Students can utilize the paper when analysing American corporate bonds. In it, there are a number of fascinating areas for future research (Antolin & Blommestein 2007). Future researchers should prolong the structural approach by introducing risk-free term edifices in prototypes with endogenous insolvency hurdles. Similarly, they should design liquidity premium with caution.

Structural prototypes of business bond yields can be approximated using monthly records of yield catalogues (Aguirregabiria 2004). Based on a standard established by Merton in the 1970s, structural prototypes are categorized as dependent claims on the properties of a company (Dutordoir, Strong, & Ziegan 2014). The study offers an understanding into business bond yields. The analysis is relevant for big businesses and institutions. New companies will find it particularly helpful in gaining an understanding of how the bond market operates. In the future, students can utilize the paper when analysing American corporate bonds. Unlike other previous researches on the topic, this research will prolong the structural approach by introducing risk-free term edifices in prototypes with endogenous insolvency hurdles. To assess the models and offer a basis for evaluation a methodology comprising a comprehensive framework, which lead to closed form explanations with the instance of continuous voucher bonds that nests the typical prototype of Merton and modern contributions will be utilized.

The proposed research paper will attempt to identify a link between business yields and cumulative actions of leverage and volatility. In a bid to identifying the link, the research proposal paper attempts to answer a number of sub-questions. Below are the research questions:

1. What is the relationship between firm-value-based models and the value of firms?
2. Are the discrepancies of leverage and volatility responsible for the time sequence variations noted in business yields?
3. What is the relationship between the newly established models and Merton prototype?

Literature review

Black Scholes and Merton pioneered the structural prototype of corporate bond yields in the 1970s (Benson & Marks 2010). By assessing the capital edifices of firms, the Merton prototype perceives equity as a call choice of business assets. Nevertheless, this simple prototype is insufficient to illustrate circumstances for the reason that it eliminates the likelihood of default before maturity (Campbell & Taksler 2003). Ever since the 1970s, extensions and modifications of structural prototypes have been constantly improved by adding a default barrier (Chamon & Mauro 2006). In the year 1977, Geske considered a business coupon bond as a collection of complex choices (Enders, & Bandalos 2001). Geske came up with a modest structure that utilizes default barrier and stochastic interest rate (Gkougkousi 2013). The two elements are integrated with business coupon bonds. In the year 1996, Leland and Toft came up with a comprehensive capital portfolio to govern business bond value (Eom 2003). In the year 2001, Collin-Dufresne and Goldstein projected an uncontrolled default barrier methodology to design the target leverage-ratio to ensure that the fault in valuing temporary bonds with the LS prototype can be lessened.

Ewald asserts that for every prototype must be to be able to illustrate specific market phenomena (Ewald & Geissler 2013). However, it is vital to support experimental proof with actual data. Jones, Mason, and Rosenfeld in the year 1984 became the first individuals to test the Merton model (Qi & Wu 2010). Using the illustration of firms with modest capital edifices and bond prices in the market in the late 1970s, the three scholars indicated that the projected values obtained from the Merton model were excessively high (Li & Wong, 2008). The values were estimated at 4.52%. In the year 1987, a similar experiment was undertaken with the help of newly released bonds and similar findings were obtained (Tsay 2012). During the early 2000, Lyden and Saraniti compared and contrasted the operation of the Merton and other models (Halkos & Papadamou 2006). In the experiment, the two scholars noted that yield spreads were undervalued when Merton prototype was utilized (Kuehn & Schmid 2014). Similarly, the studies indicated that the LS prototype had no substantial progress.

In the year 2004, Eom, Helwege and Huang undertook an inclusive experimental investigation of structural models (Coles, Lemmon & Felix 2012). In the experiment, the researchers tested a number of structural prototypes. During the experiment, the asset payout and stochastic interest rate were considered (Rosa 2013). After prudent scrutiny, the researchers were able to illustrate a sample of bonds between the years 1986 and 1997 (Tsuji 2015). To apply the structural prototypes, the researchers substituted the market cost of business properties by the amount of the market cost of equities and the cost of aggregate liabilities (Johnson 2007). Dissimilar ways were utilised in approximating the other prototype’s parameters (Qu 2009). In the experiment, both the Merton and Geske prototypes undervalued yield extents (Finnerty 2014). In spite of their empirical findings, Eom, Helwege and Huang postulated a prolonged Merton prototype (Maurol 2005). The prototype is applied in coupon bonds. The prototype establishes a number of principles for bond selection.

Hypotheses

The hypothesis in this research will be based on the research conducted by Anderson and Sundaresanin the year 2000. We state that our null hypothesis, models, are dependent, V, the cost of the firm.

Anderson and Sundaresanin noted that the null hypothesis or the models fitted perfectly well suggesting that disparities of leverage and property unpredictability is the reason for much of the time sequence variations of detected business yields. It was also noted that the operation of the new prototypes that integrate endogenous insolvency hurdles is slightly higher compared to the original Merton prototype.

Anderson and Sundaresanin prototype presumes that asset insolvency is expensive and that fractional liquidations of properties are not practical. However, based on the above prototype it will be observed that organizations would compensate prescribed service on unresolved debt up to the point the property cost decreases to the level where the cost of equity is zero (Murik 2012). At this level, the organization is liquidated and the bond owners receive the accessible security.

Data collection

Just like in A Comparative Study of Structural Models of Corporate Bond Yields, the data utilized in the article were collected from the American financial institutions (Teixeira 2007). Other sources utilized in the research included the S&P, American stock market index, NYSE, S & P Dow Jones index, MV, WRDS, DATASTREAM, banks, and CRSP US stock databases. In this case, the institutions offered the researchers with approximated collective time figures for the American corporate bond market. The figures collected were from the years 2000 to 2014. Similar to A Comparative Study of Structural Models of Corporate Bond Yields, the following variables were considered in the evaluation of the bonds.

• P_t = proxy for leverage
• AV_t= proxy for asset volatility

Volatility= an arithmetical ration of the distribution of returns for a specific security. It can either be assessed with the help of a standard deviation or discrepancy between the returns from similar market index. As such, the higher the volatility the riskier the security.

Methodology

The paper follows Anderson and Sundaresan’s model for constructing and an analysis of the null hypotheses:

The null hypothesis, models, are dependent on a single variable V. V represents the cost of the firm. B represents the worth of the bond. C represents the coupon percentage. P represented the principal, whereas r represents the risk free proportion. The fiscal distress costs in situation of default are represented by the comparative retrieval rate θ. The stable insolvency cost is represented by the symbol K. P_d represents a likelihood of default. V^* represents the default hurdle.

Thereafter, we assess how the distinctive situations of the chosen prototype resembled the continuous prototypes of Leland and Merton. It should be noted that when Leland structures were used the cost process tracked a symmetrical Brownian motion with drift (µ─β) V. β represents a cash flow expenditure rate. Based on the above models, the default probability illustrated below is established.

When y ² < 0, it is observed that 0< P_d < 1⁶. Similarly, it should be noted that as V drew near V^* , the likelihood of of default drew near one. As such, the Leland and the AST are differentiated in the manner through which they defined the generation point V^*.

Using the above equations, the models can assessed using collective time sequence data for the American business bond market. The time series are from august 2000 through december 2014. Monthly sequence of this measure are generated supposing entire charges and the interrests ratio follows constant annual trends. Leverage scrutiny in a month is represented as P_t. The volatility of equity yields is evaluated as the standard deviation of monthly yields for a period of 12 months.

The goal of this paper was to assess the structural models of corporate bond yields. As such, corporate organizations were the target population from which samples were taken (Teixeira 2007). In this case, the institutions offered the researchers with approximated collective time figures for the American corporate bond market. The figures collected were from the years 2000 to 2014.

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