Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/178570
Authors: 
Huang, Zhijian
Luo, Yuchen
Year of Publication: 
2016
Citation: 
[Journal:] Journal of Risk and Financial Management [ISSN:] 1911-8074 [Volume:] 9 [Year:] 2016 [Issue:] 2 [Pages:] 1-20
Abstract: 
The ground-breaking Black-Scholes-Merton model has brought about a generation of derivative pricing models that have been successfully applied in the financial industry. It has been a long standing puzzle that the structural models of credit risk, as an application of the same modeling paradigm, do not perform well empirically. We argue that the ability to accurately compute and dynamically update hedge ratios to facilitate a capital structure arbitrage is a distinctive strength of the Black-Scholes-Merton's modeling paradigm which could be utilized in credit risk models as well. Our evidence is economically significant: We improve the implementation of a simple structural model so that it is more suitable for our application and then devise a simple capital structure arbitrage strategy based on the model. We show that the trading strategy persistently produced substantial risk-adjusted profit.
Subjects: 
credit risk
structural models
credit default swap
JEL: 
G12
G13
Persistent Identifier of the first edition: 
Creative Commons License: 
https://creativecommons.org/licenses/by/4.0/
Document Type: 
Article

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