SPECIFICATION ANALYSIS OF STRUCTURAL CREDIT RISK MODEL WITH STOCHASTIC VOLATILITY

Authors

  • OKOLI, OBUIKEM AMOS Institution: Anambra State Polytechnic, Mgbakwu. Dapartment: General Study Unit
  • Onwughalu Anita Anambra State Polytechnic, Mgbakwu

DOI:

https://doi.org/10.53555/nnbma.v9i5.1697

Keywords:

Structural Credit Risk Model, Stochastic Volatility, Credit Default Swap Spreads, Consistent Specification Analysis, Pricing Error Diagnostics.

Abstract

In this research, we conduct specification analysis of structural credit risk models with stochastic volatility using term structure of Credit Default Swap (CDS) spreads and equity volatility form high-frequency return data. We also test five representatives of structural  credit risk models using  samples of 93 single name CDS contracts from January 2010 -2022. The model we consider are; the  standard Merton(1974) model, the Black & Cox (1976) model with flat barrier, the Longstaff and Schwartz(1995)model with stochastic interest rates, the Collin- Dufresne and Goldstein (2001) model with stationary leverage, and the  double exponential jump diffusion model used in  Huang & Huang(2003). Our study provides consistent econometric estimation of the pricing model parameters and specification tests based on the joint behavior of time-series asset dynamics and cross-sectional pricing errors. Our empirical tests reject strongly the standard Merton (1974) model, the Black and Cox (1976) with flat barrier model, the Longstaff, Schwartz (1995) model with stochastic interest rates. The double exponential jump-diffusion barrier model used in (Huang and Huang, 2003) improves significantly over the five models. The best model is the stationary leverage model of Collin-Dufresne and Goldstein (2001), which we cannot reject at 0.5 level of significance in our sample firm. However, our empirical results document the inability of the existing structural models to capture the dynamic behavior of CDS spreads and equity volatility, especially for high investment grade names derivatives. These points to a potential role of time-varying asset volatility, a feature that is missing in the standard structural models.

References

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Published

26-05-2023

How to Cite

OBUIKEM AMOS, O. ., & Anita, O. (2023). SPECIFICATION ANALYSIS OF STRUCTURAL CREDIT RISK MODEL WITH STOCHASTIC VOLATILITY. Journal of Advance Research in Business, Management and Accounting (ISSN: 2456-3544), 9(5), 35-42. https://doi.org/10.53555/nnbma.v9i5.1697

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