Jones, E. Philip, Scott P. Mason, and Eric Rosenfeld, "Contingent Claims Analysis of Corporate Capital Structures: an Empirical Investigation", Journal of Finance, Vol. 39, No. 3, (July 1984), pp. 611-625.
Beginning: In their seminal work Black and Scholes (1973) provide a significant insight which arguably is of more academic and practical value than their famous option pricing model. They demonstrate that corporate liabilities can be viewed as combinations of simple option contracts. This generalization of option pricing as refined by Merton (1974, 1977), has become known as Contingent Claims Analysis (CCA). While CCA has subsequently been used by many researchers as a theoretical framework in which to view the pricing of corporate liabilities, it's the model's ability to predict prices for dual purpose funds and call policies for convertible bonds respectively. In a recent paper, JMR (1983), we tested CCA in one of its potentially most important applications, namely the valuation of debt in typical corporate structures. The objective of JMR (1983) was to test the predictive power of a prototypical model based on the usual set of assumptions in the CCA literature. The data base used in JMR (1983) was made up primarily of investment grade bonds, i.e., bond rating of BBB or higher. This paper extends that test of the prototypical model to a large data base which includes a number of noninvestment grade, or "junk", bonds. In addition, this paper demonstrates that in the multiple bond problem the value of callable debt need not be a monotonic function of the firm value.