Mimicking Credit Ratings by a Perpetual-Debt Structural Model

In this paper, we outlined 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, that we will call Perpetual Debt... [ view full abstract ]

In this paper, we outlined 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, that we will call Perpetual Debt Structural Model (PDSM), stocks are equivalent to a portfolio that contains a perpetual American option to default.This paper aims to offer a first empirical test of the model. Essentially, the question is: «Is the PDSM is sufficiently flexible to give default probabilities consistent with those historically estimated by Moody’s?». The answer is positive. The paper contains a simple firm-level application.