Estimating Structural Bond Pricing Models

by Jan Ericsson of McGill University, and
Joel Reneby of the Stockholm School of Economics

March 2005

Abstract: A difficulty that arises when implementing structural bond pricing models is the estimation of the value and risk of the firm's assets, neither of which is directly observable. We perform a simulation experiment to evaluate a maximum likelihood method applicable to this problem. Contrasting the performance of the maximum likelihood estimators to that of estimators traditionally used in academia and industry, we find strong support for the maximum likelihood approach. In fact, the inefficiency of the traditional estimator may help explain the failure of past attempts to implement structural bond pricing models.

JEL Classification: G12, G13.

Keywords: Credit Risk, Maximum Likelihood, Corporate Bonds.

Published in: Journal of Business, Vol. 78, No. 2, (March 2005), pp. 707-735.

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