Merton Model

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The goal of this project is to apply the Merton Model (and potentially an enhancement to the Merton model) to different firms over time to exploit capital structure arbitrage opportunities between equity prices and CDS. More concretely, we ought to compare model-derived CDS spreads to market observables, and implement a trading strategy over a time horizon to determine how profitable these arbitrage strategies are. The main achievements reached so far are the computation on Matlab of the probabilities of default of the companies that we had chosen then making an assumption on the Recovery rate we've got the CDS Spreads. As proposed we have chosen High Yields companies rated BB or single B from Bloomberg after that we have compared the CDS Spreads calculated by our model and the ones observed on the Equity Market. As a result, it turns out that theses probabilities of default were very small so we were obliged to do some assumptions by manipulating historical data. As a matter of fact, we've implemented the CreditGrades Model to get some reasonable probabilities of default or CDS spreads. Besides, we've noticed discrepancies between the predicted spreads and the actual ones so the wider the difference, the better the strategy as the CDS is then miss-priced. To sum up, the Merton Model demonstrated that Equity is a Call option on the value of the firm, linking the Equity and the Debt. • • Retrouvez l'ESILV sur : • Facebook : / esilvparis • Twitter : / esilvparis • Linkedin : http://bit.ly/25WVOCa • Pinterest : / pleuniversitair • Google+ : https://plus.google.com/+esilv • http://www.esilv.fr

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