This paper develops and tests a method of extracting expectations about default losses on corporate debt from yield spreads. It is based on calibrating theMerton (1974) model to yield spread, leverage and equity volatility. For rating classes, the approach generates forwardlooking expected...

This article examines the contribution of hedging to firm value and the cost of hedging in a unified framework. Optimal hedging and firm value are explicitly linked to firm risk, the type of debt covenants and the relative priority of the hedging contract. It is shown that in some cases hedging...

This paper proposes a practical way of estimating the cost of risky debt for use in the cost of capital. The cost of debt is different from both the promised yield and the risk-free rate, which are sometimes used for this purpose, because of the expected probability of default. The Merton (1974)...

The Pettengill et al (1995) test of the conditional relationship between beta and returns has recently become widely used. This paper shows that there is a large bias in that test. The test is almost guaranteed to be satisfied, regardless of the model that generates expected returns. In...

We demonstrate, using a simple model, how netting as a design feature of financial contracts has a major effect on default risk. Under general conditions netting of cash flows within a contract is shown to eliminate all first-order effects of default risk. We state the model as both a...

This paper extends the literature on international capital market equilibrium and corporate finance. We modify the Stulz (1981) model to include an arbitrary number of assets and countries and an arbitrary structure of investment costs. Unlike models that simply assume particular kinds of...