Abstract
Among the structural form credit models, this is one of the first few studies that suggest an intrinsic valuation approach that uses the present value of a firm's future cash flows instead of its equity market value to estimate its asset value distribution. We employ an industrial cyclicality linked mean-reverting Gaussian process to model a firm's free cash flows to generate its multi-period unconditional asset value distributions. A firm's unconditional multi-period probability of defaults and expected recovery rates can then be estimated endogenously. The credit information is also useful in pricing corporate bonds.
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