Working Paper: NBER ID: w1143
Authors: E. Philip Jones; Scott P. Mason; Eric Rosenfeld
Abstract: Although the Contingent Claims Analysis model has become the premier theory of how value is allocated among claimants on firms,its empirical validity remains an open question. In addition to being of academic interest, a test of the model would have significant practical implications. If it can be established that the model predicts actual market prices, then the model can be used to price new and untraded claims, to infer firm values from prices of traded claims like equity and to price covenants separately. In this paper evidence is presented on how well a model which makes the usual assumptions in the literature does in predicting market prices for claims in standard capital structures. The results suggest that the usual assumption list requires modification before it can serve as a basis for valuing corporate claims.
Keywords: contingent claims; corporate liabilities; capital structure; market prices
JEL Codes: G12; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Model's assumptions (C51) | Predictive capability for market prices (G17) |
| Model can predict market prices (G17) | Model can price new and untraded claims (G19) |
| Modifications to assumptions (C59) | Enhanced predictive accuracy (C52) |
| Zero personal taxes assumption (H29) | Systematic pricing errors (L11) |
| Constant variance assumption violation (C22) | Underpricing of safer bonds (G12) |
| Constant variance assumption violation (C22) | Overpricing of riskier bonds (G12) |
| Bond ratings (G12) | Pricing errors (D49) |