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Archive » May 2018 » Replication of credit ratings by a Perpetual-Debt Structural Model

Replication of credit ratings by a Perpetual-Debt Structural Model

Gaia Barone
May 2018 - n. 5
Jel codes: G13

In this paper, we outline the general lines of a structural model that is based on the Leland model (1994), but differs from its assumptions about the tax regime. In the revised model, which we call the Perpetual-Debt Structural Model (Pdsm), stocks are equivalent to a portfolio that contains a perpetual American option to default. The paper offers a first empirical test of the model. Essentially, the question is: Is the Pdsm sufficiently flexible to give default probabilities consistent with those historically estimated by Moody’s? The answer is positive. The paper contains also a simple firmlevel application.

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