Authors: Athanasios Episcopos, George Leledakis

Title: Further evidence on the barrier options model of corporate security valuation

Abstract

In the barrier option model of corporate security valuation, the firm’s creditors impose a default-triggering barrier on the firm value to protect their claim. One of the disputed issues in the literature is whether the implied default barrier as a proportion of firm value is positive, and whether it is above or below the firm’s leverage. Other issues of interest include the barrier determinants, the effect of debt maturity on the barrier, and the relationship of the barrier with the risk-neutral probability of default. Using a sample of US stocks from the NYSE, AMEX and NASDAQ, our paper attempts to exploit market and firm information to arrive at more accurate estimates of the model parameters. The barrier is estimated for thirty 2-digit SIC groups including industrials and banks. Our initial results are encouraging and show the following: a) The implied barrier is less than it is in the received literature. b) The barrier can be less that leverage, even zero for some firms. c) The risk-neutral probability of default is less than it is in the literature. Thus, our revisions of the default barrier estimates lead to a reexamination of the previous literature findings in the industrial and banking sectors.