Structural Modelling of Credit Spreads on the European Bond Market: An Empirical Study
Abstract: This thesis empirically tests the explanatory power of structural models on the European corporate bond market. Using new evaluation methods, including LASSO and gradient boosting regression, we can provide an in-depth assessment of the models’ shortcomings. With these tools we show that the structural models tend to systematically overstate or understate the spread due to an oversensitivity to leverage ratio and asset volatility. We introduce a novel extension to the Black Cox model in order to mitigate the observed weaknesses. Our extension is calibrated to match historical default probabilities with an additional baseline default risk component attributable to all ﬁrms. This approach manages to increase the R-squared from 39 % to 47 % and at the same time reduce the residual dependencies of leverage ratio and asset volatility.
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