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Rev Fin 2004; 17:499-544
The Review of Financial Studies Vol. 17, No. 2, pp. 499–544 © 2004 The Society for Financial Studies; all rights reserved.

Structural Models of Corporate Bond Pricing: An Empirical Analysis

Young Ho Eom
Yonsei University

Jean Helwege
University of Arizona

Jing-Zhi Huang
Penn State University

Address correspondence to Jing-Zhi Huang, Smeal College of Business, Penn State University, University Park, PA 16802, or e-mail: jxh56{at}psu.edu.

This article empirically tests five structural models of corporate bond pricing: those of Merton (1974), Geske (1977), Longstaff and Schwartz (1995), Leland and Toft (1996), and Collin-Dufresne and Goldstein (2001). We implement the models using a sample of 182 bond prices from firms with simple capital structures during the period 1986–1997. The conventional wisdom is that structural models do not generate spreads as high as those seen in the bond market, and true to expectations, we find that the predicted spreads in our implementation of the Merton model are too low. However, most of the other structural models predict spreads that are too high on average. Nevertheless, accuracy is a problem, as the newer models tend to severely overstate the credit risk of firms with high leverage or volatility and yet suffer from a spread underprediction problem with safer bonds. The Leland and Toft model is an exception in that it overpredicts spreads on most bonds, particularly those with high coupons. More accurate structural models must avoid features that increase the credit risk on the riskier bonds while scarcely affecting the spreads of the safest bonds.


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