Marking to Market Corporate Debt

Lorenzo Bretscher, Peter Feldhütter, Andrew Kane and Lukas Schmid
Additional contact information
Lorenzo Bretscher: University of Lausanne and Swiss Finance Institute
Peter Feldhütter: Copenhagen Business School
Andrew Kane: Duke University, Fuqua School of Business, Students
Lukas Schmid: University of Southern California - Marshall School of Business

No 21-06, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Models of capital structure and credit risk make predictions about market valuations of debt, but are routinely tested on the basis of book debt from common data sources. In this paper, we propose to close this gap. We construct a rich data set on firm level debt market valuations by carefully matching data on corporate bond and loan secondary market transactions. We document significant discrepancies between market and book values, especially for distressed firms. We use our dataset to i) provide novel rules of thumb on how to adjust leverage and unlever returns using standard datasets, and ii) to revisit a number of prominent empirical patterns involving corporate debt. Using a market-based measure of Tobin's Q, we find little evidence for investment cash-flow sensitivity in our data. We find that using market debt values significantly improves default prediction, and do not detect a credit spread puzzle. In asset pricing tests, we find a leverage premium, but no evidence for a value premium after controlling for market leverage. Moreover, a novel measure of financial distress, namely market-to-book debt, predicts stock returns positively in the cross-section, inconsistent with a financial distress puzzle.

Keywords: Corporate Debt Valuations; Tobin's Q; Leverage Premium (search for similar items in EconPapers)
Pages: 81 pages
Date: 2021-01
New Economics Papers: this item is included in nep-ban and nep-rmg
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2106

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