Better Ingredients
Research Paper
April 1, 2005
Preview
In this month's research note, we examine the relationship between the equity, equity options and credit markets through the structural model framework. Using our CreditGrades implementation of the structural model, we investigate the ability of the model to forecast actual credit spreads. We analyze Vivendi Universal, which underwent a credit crisis in 2002, but has now recovered, and General Motors, which is arguably the most watched credit at present. From our analysis of these two firms, we learn that options information can significantly improve the model's spread forecasts, and that taken together, the options and credit markets can inform us on the true level of a firm's leverage. We conclude with some thoughts on how these modeling enhancements can help risk managers in practice.
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