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Default Risk in Asset Pricing

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  • Pierre Mella-Barral
  • Pierre Tychon

Abstract

This paper provides an analytical solution for the impact of default risk on the valuation of realistically intricate claims on time-dependent uncertain income streams. Its modular structure allows us to adjust the set of assumptions concerning the event of default to the specificity of the environment which surrounds the asset. The importance of such a flexibility is illustrated in the context of corporate debt, examining the simplest case of finite-lived coupon-paying corporate bonds with principal repayment at maturity. The magnitude of risk premia, as well as the term structure of credit spreads, are, not surprisingly, largely determined by the assumed default scenario.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp250.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp250.

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Date of creation: Oct 1996
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Handle: RePEc:fmg:fmgdps:dp250

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Web page: http://www.lse.ac.uk/fmg/

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  1. Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
  2. Fries,S. & Mella-Barral,P. & Perraudin,W.R.M., 1995. "Optimal Bank Reorganisation and the Fair Pricing of Deposit Garantees," Cambridge Working Papers in Economics 9417, Faculty of Economics, University of Cambridge.
  3. Leonardo Bartolini & Avinash K. Dixit, 1990. "Market Valuation of Illiquid Debt and Implications for Conflicts Among Creditors," IMF Working Papers 90/88, International Monetary Fund.
  4. Hayri, Aydin, 2000. "Debt relief," Journal of International Economics, Elsevier, vol. 52(1), pages 137-152, October.
  5. Pierre Mella-Barral & William R M Perraudin, 1993. "Strategic Debt Service," CEPR Financial Markets Paper 0039, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
  6. Brennan, Michael J & Schwartz, Edwardo S, 1978. "Corporate Income Taxes, Valuation, and the Problem of Optimal Capital Structure," The Journal of Business, University of Chicago Press, vol. 51(1), pages 103-14, January.
  7. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
  8. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
  9. Pierre Mella-Barral, 1996. "The Dynamics of Corporate Debt forgiveness and Contract Renegotiation," FMG Discussion Papers dp230, Financial Markets Group.
  10. Altman, Edward I, 1984. " A Further Empirical Investigation of the Bankruptcy Cost Question," Journal of Finance, American Finance Association, vol. 39(4), pages 1067-89, September.
  11. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  12. In Joon Kim & Krishna Ramaswamy & Suresh Sundaresan, 1993. "Does Default Risk in Coupons Affect the Valuation of Corporate Bonds?: A Contingent Claims Model," Financial Management, Financial Management Association, vol. 22(3), Fall.
  13. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
  14. Alderson, Michael J. & Betker, Brian L., 1995. "Liquidation costs and capital structure," Journal of Financial Economics, Elsevier, vol. 39(1), pages 45-69, September.
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Cited by:
  1. Manzoni, Katiuscia, 2002. "Modeling credit spreads: An application to the sterling Eurobond market," International Review of Financial Analysis, Elsevier, vol. 11(2), pages 183-218.
  2. Marco Realdon, 2006. "Book Values and Market Values of Equity and Debt," Discussion Papers 06/11, Department of Economics, University of York.
  3. Marco Realdon, 2007. "Valuation of the Firm's Liabilities When Equity Holders Are Also Creditors," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(5-6), pages 950-975.
  4. Marco Realdon, . "Corporate Bond Valuation with Both Expected and Unexpected Default," Discussion Papers 03/21, Department of Economics, University of York.
  5. Marco Realdon, . "Convertible Subordinated Debt Valuation and "Conversion in Distress"," Discussion Papers 03/18, Department of Economics, University of York.

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