Alter the capital credit structure
The management option to alter the capital structure establishes the link between structural models and fundamental credit analysis. It may be remembered that in the Merton framework the strike price of both the call and the put option on the firm’s assets changes when the capital structure of a company changes. This is undoubtedly one of the strategic risks a credit analyst has to evaluate. But there are further points that potentially may have a strong impact on credit spreads, but cannot be captured by quantitative models. Pension liabilities, off-balance-sheet items and litigation risk, which have been major drivers of credit spreads recently, are typical examples. Therefore, we feel that it is most promising not to concentrate on a purely quantitative or a purely fundamental approach.
Combinations of both may prove particularly insightful. Undoubtedly, none of the analyzed approaches works in every environment. But experienced and sophisticated managers will be able to select the best method for a given investment situation.
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