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Corporate Bond Valuation and Hedging with Stochastic Interest Rates and Endogenous Bankruptcy

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Author Info
Acharya, Viral V
Carpenter, Jennifer

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Abstract

This Paper analyses corporate bond valuation and optimal call and default rules when interest rates and firm value are stochastic. It then uses the results to explain the dynamics of hedging. Bankruptcy rules are important determinants of corporate bond sensitivity to interest rates and firm value. Although endogenous and exogenous bankruptcy models can be calibrated to produce the same prices, they can have very different hedging implications. We show that empirical results on the relation between corporate spreads and Treasury rates provide evidence on duration and find that the endogenous model explains the empirical patterns better than typical exogenous models.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3328.

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Date of creation: Apr 2002
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Handle: RePEc:cpr:ceprdp:3328

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Related research
Keywords: call; corporate bonds; default; duration; endogenous bankruptcy; hedging; optimal exercise boundary; stochastic interest rates;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Abel Elizalde, 2006. "Credit Risk Models Ii: Structural Models," Working Papers wp2006_0606, CEMFI. [Downloadable!]
  2. C.N.V. Krishnan & Peter H. Ritchken & James B. Thomson, 2007. "On forecasting the term structure of credit spreads," Working Paper 0705, Federal Reserve Bank of Cleveland. [Downloadable!]
  3. Ralph S.J Koijen & Otto Van Hemert & Stijn Van Nieuwerburgh, 2007. "Mortgage Timing," NBER Working Papers 13361, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Augusto Castillo, 2004. "Firm and Corporate Bond Valuation: A Simulation Dynamic Programming Approach," Cuadernos de Economía (Latin American Journal of Economics), Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 41(124), pages 345-360. [Downloadable!]
  5. Jing-zhi Huang & Hao Zhou, 2008. "Specification analysis of structural credit risk models," Finance and Economics Discussion Series 2008-55, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  6. Linda Allen & Anthony Saunders, 2004. "Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature," Journal of Financial Services Research, Springer, vol. 26(2), pages 161-191, October. [Downloadable!] (restricted)
  7. Sbuelz, A. & Guha, R., 2003. "Structural rfv: recovery form and defaultable debt analysis," Discussion Paper 37, Tilburg University, Center for Economic Research. [Downloadable!]
  8. Luciano Campi & Simon Polbennikov & Sbuelz, 2005. "Assessing Credit with Equity: A CEV Model with Jump to Default," Working Papers 24, Università di Verona, Dipartimento di Scienze economiche. [Downloadable!]
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