Forte, S. and Peña, J.I, 2009, "Credit Spreads: An Empirical Analysis on the Informational Content of Stocks, Bonds, and CDS", Journal of Banking and Finance 33, 2013-2025. Download this paper (JBF)
Forte, S., 2009, "Capital Structure: Optimal Leverage and Maturity Choice in a Dynamic Model", Revista de Economía Financiera 18, 62-80. Download this paper (SSRN)
Working Papers
"Pseudo Maximum Likelihood Estimation of Structural Credit Risk Models with Exogenous Default Barrier". 2009. (with Lidija Lovreta).
In this paper we propose a novel approach to the estimation of structural credit risk models with exogenous default barrier. The method consists of an iterative algorithm which, on the basis of the log-likelihood function for the time series of equity prices, provides pseudo maximum likelihood (ML) estimates of the default barrier and of the value, volatility, and expected return on the firm’s assets. We demonstrate empirically that, contrary to the standard ML approach, the proposed method ensures that the default barrier always falls within reasonable bounds. Moreover, theoretical credit spreads based on pseudo ML estimates offer the lowest credit default swap pricing errors when compared to the options that are usually considered when determining the default barrier: standard ML estimate, endogenous value, KMV’s default point, and principal value of debt.
"Credit Risk Discovery in the Stock and Credit Default Swap Market: Who Leads, When, and Why?".2009. (with Lidija Lovreta).
In this paper, we analyze the dynamic relationship between CDS spreads and stock market implied credit spreads for a large international set of companies during the period 2002-2004. We document a time-varying behavior of credit risk discovery, with a slight and declining dominance of the stock market during the period considered. The probability of such stock market leadership – along with the strength of the relationship between stock and CDS markets – increases with the overall credit risk level. This result, however, is not inconsistent with the argument of insider trading in credit derivatives; we document a positive relationship between the frequency of severe credit downturns and the probability of the CDS market leading credit risk discovery.
"Implied Default Barrier in Credit Default Swap Premia". 2008. (with Francisco Alonso and José Manuel Marqués)
This paper applies the methodology developed by Forte (2008) to extract the implied default point in the premium on credit default swaps (CDS). As well as considering a more extensive international sample of corporations (96 US, European and Japanese companies) and a longer time interval (2001-2004), we make two significant contributions to the original methodology. First, we calibrate bankruptcy costs, allowing for the adjustment of the mean recovery rate of each sector to its historical average. Second, and drawing on the sample of default point indicators for each company-year obtained, we propose an econometric model for these indicators that excludes any reference to the credit derivatives market. With this model it is thus possible to estimate the default barrier resorting solely to the equity market. Compared with other alternatives for setting the default point in the absence of CDS (such as the optimal default point for shareholders, the default point in the Moody's-KMV model or the face value of the debt), the out-of-sample use of the econometric model significantly improves the capacity of the structural model proposed by Forte (2008) to differentiate between companies with an investment grade rating (CDS less than 150 bp) and those with a non-investment grade rating.
"Calibrating Structural Models: A New Methodology Based on Stock and Credit Default Swap Data". 2009.
This paper presents a modified version of Leland and Toft’s (1996) structural credit risk model, together with a novel calibration methodology based on stock and CDS data: the firm asset value and volatility are consistently derived from equity prices; the default barrier is calibrated from CDS premia. It empirically shows that as long as the appropriate default barrier is selected, the model generates time series of stock market implied credit spreads which fit the times series of CDS spreads. Moreover, CDS implied default barriers prove to be consistent with stockholders’ rationality, with predictions made by structural models with endogenous default, and with historical recovery rates. Based on the parameter values obtained, estimations of the distance to default are also reported which exhibit a positive relationship with the rating of the company, and a negative relationship with the corresponding CDS spread; in both cases the evidence is highly significant.
"Debt Refinancing and Credit Risk". 2003. (with Juan Ignacio Peña)
Many firms choose to refinance their debt. We investigate the long run effects of this extended practice on credit ratings and credit spreads. We find that debt refinancing generates systematic rating downgrades unless a minimum firm value growth is observed. Deviations from this growth path imply asymmetric results: A lower value growth generates downgrades and a higher value growth upgrades as expected. However, downgrades will tend to be higher in absolute terms. On the other hand, credit spreads will be independent of the risk free interest rate in the short run, but positively correlated with this rate in the long run.
