The role of asset payouts in the estimation of default barriers

Alexandros Bougias, Athanasios Episcopos and George Leledakis

MPRA Paper from University Library of Munich, Germany

Abstract: In the barrier option model of corporate security valuation, the firm’s creditors impose a default-triggering barrier on the firm value to protect their claim. Two disputed issues in the literature are whether the implied default barrier is positive, and whether it is above or below the book value of the firm’s liabilities. We extend the model of Brockman and Turtle (2003, Journal of Financial Economics 67, 511–529) by embedding asset payouts in the valuation of shareholders’ equity. Using a sample of US stocks from the NYSE, AMEX, and NASDAQ exchanges, our paper exploits market and firm information to compute the implied default barrier for thirty 2-digit SIC groups, including industrials and banks. Our results show that the implied default barrier is lower than it is in the received literature, and it can be less than total liabilities, even zero for some firms. The implied physical default probabilities are significantly lower in the presence of payouts, providing a closer fit to the historical corporate default rates, particularly for issuers of speculative-grade bonds.

Keywords: Contingent claims; Barrier option; Issuer credit ratings; Default barrier; Asset payouts (search for similar items in EconPapers)
JEL-codes: G12 G33 (search for similar items in EconPapers)
Date: 2022-02-24
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: The role of asset payouts in the estimation of default barriers (2022)
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