Structural Credit Models and the Bond–Equity Relationship

Summary

The document asks whether a company’s corporate bond price has a formula-based relationship with its stock price. The response points to structural credit models, such as the Merton model, as frameworks that connect a firm’s equity and debt through the value and risk of the company’s assets.

It also cautions that the assumptions used to price equity options through delta hedging and no-arbitrage arguments do not directly hold in this setting, because company assets are not tradable. The short response names a modeling approach and an important limitation, but provides no derivation, equation, empirical evidence, or specific bond-to-stock pricing relationship. It therefore serves as a pointer to structural credit modeling rather than a complete explanation of how to estimate the relationship.

Key ideas

• Structural credit models, including the Merton model, relate a company’s equity and debt to its assets.
• The response notes that company assets are not tradable.
• Option-pricing assumptions based on delta hedging and no-arbitrage do not directly apply in this setting.
• The document points toward a modeling framework but does not provide a formula or empirical analysis.

Tags

# Bond and Stock Relationship


# Bond and Stock Relationship












Is there any formulair relationship between the price of a corporate bond and the stock on the same company?

## Answer by Charles Fox (score 1, accepted)

https://quant.stackexchange.com/a/41915

Structural credit models like the Merton Model attempt to establish the relationship. However, because the company assets are not trade-able, the delta hedging / no arbitrage assumptions associated with pricing equity options do not hold in this case. This article provides some additional information.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.