Evaluation of conducting capital structure arbitrage using the multi-period extended Geske–Johnson model

Hann Shing Ju, Ren Raw Chen, Shih Kuo Yeh, Tung Hsiao Yang*

*Corresponding author for this work

Research output: Contribution to journalJournal Article peer-review

5 Scopus citations

Abstract

This study utilizes a multi-period structural model developed by Chen and Yeh (Pricing credit default swaps with the extended Geske–Johnson Model. Working paper, 2006), which extends the Geske and Johnson (J Financ Quant Anal 19:231–232, 1984) compound option model to evaluate the performance of capital structure arbitrage. In the paper, first of all, we predict the default probability for each firm using the multi-period Geske–Johnson model that assumes endogenous default barriers. Second, based on the arbitrage performance of 369 North American obligators from 2004 to 2008, we find that the extended Geske–Johnson model is more suitable than the CreditGrades model for exploiting the mispricing between equity prices and credit default swap spreads. Finally, the Geske–Johnson model also performs well in extreme market condition, such as the financial crisis around 2008.

Original languageEnglish
Pages (from-to)89-111
Number of pages23
JournalReview of Quantitative Finance and Accounting
Volume44
Issue number1
DOIs
StatePublished - 01 2013
Externally publishedYes

Bibliographical note

Publisher Copyright:
© 2013, Springer Science+Business Media New York.

Keywords

  • Capital structure arbitrage
  • Geske–Johnson model
  • Structural model

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