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Defaultable Puttable/Callable Bond Valuation: A 3D Finite Difference Model

Author

Listed:
  • David Wang

    (Hsuan Chuang University, Taiwan)

  • Heng-Chih Chou

    (Ming Chuan University, Taiwan)

Abstract

This paper presents a 3D model for pricing defaultable bonds with embedded put/call options. The pricing model incorporates three essential ingredients in the pricing of defaultable bonds: stochastic interest rate, stochastic default risk, and put/call provision. Both the stochastic interest rate and the stochastic default risk are modeled as a square-root diffusion process. The default risk process is allowed to be correlated with the default-free term structure. The put/call provision is modeled as a constraint on the value of the bond in the finite difference scheme. This paper can provide new insight for future research on defaultable bond pricing models.

Suggested Citation

  • David Wang & Heng-Chih Chou, 2005. "Defaultable Puttable/Callable Bond Valuation: A 3D Finite Difference Model," Finance 0511018, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0511018
    Note: Type of Document - pdf; pages: 10
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/0511/0511018.pdf
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    Cited by:

    1. Manish Tewari & Pradipkumar Ramanlal, 2022. "Risk Management and Agency Theory: Role of the Put Option in Corporate Bonds," JRFM, MDPI, vol. 15(2), pages 1-28, January.

    More about this item

    Keywords

    Defaultable Bond; Embedded Option; Partial Differential Equation; Finite Difference Method;
    All these keywords.

    JEL classification:

    • G - Financial Economics

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