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Integrating the risk and term structures of interest rates

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  • Jean-Paul Decamps

Abstract

Merton (1974) analysed the risk structure of corporate bonds under the assumption of a flat term structure of interest rates. We clarify his results and extend them to the case of stochastic interest rates. As a consequence we deal simultaneously with interest rate risk and with default risk. We investigate the price of a corporate bond and the various measures of the riskness of a corporate bond proposed by Merton ((i) the Yield difference between the corporate bond and a default free bond with the same characteristics, (ii) the standard deviation of the rate of return of a corporate bond). We demonstrate and we explain why several of Merton's conclusions are no longer valid in a stochastic term structure framework.

Suggested Citation

  • Jean-Paul Decamps, 1996. "Integrating the risk and term structures of interest rates," The European Journal of Finance, Taylor & Francis Journals, vol. 2(3), pages 219-238.
    • Handle: RePEc:taf:eurjfi:v:2:y:1996:i:3:p:219-238
    DOI: 10.1080/13518479600000006
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    1. In Joon Kim & Krishna Ramaswamy & Suresh Sundaresan, "undated". "The Valuation of Corporate Fixed Income Securities," Rodney L. White Center for Financial Research Working Papers 32-89, Wharton School Rodney L. White Center for Financial Research.
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