Journal of Financial Economics Vol. 67 No. 3 2003
A barrier option framework for corporate security valuation
Abstract
This paper proposes a framework for corporate security valuation based on path-dependent, barrier option models instead of the commonly used path-independent approach. We argue that path dependency is an intrinsic and fundamental characteristic of corporate securities because equity can be knocked out whenever a legally binding barrier is breached. A direct implication of this framework is that equity will be priced as a down-and-out call option. We provide empirical validation of the barrier model by showing that implied barriers are statistically and economically significant for a large cross-section of industrial firms. Additional robustness tests confirm that barriers remain significant over a wide range of input variable estimates. And finally, we apply the barrier option framework to bankruptcy prediction and find that implied failure probabilities dominate Z-scores in most cases.
- DOI
- 10.1016/s0304-405x(02)00260-x
- Volume
- 67
- Issue
- 3
- Pages
- 511-529
- Language
- en
- Sources
- crossref bibtex:phds-export.bib openalex