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

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Author Info

  • David Wang

    (Hsuan Chuang University, Taiwan)

  • Heng-Chih Chou

    (Ming Chuan University, Taiwan)

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    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.

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    File URL: http://128.118.178.162/eps/fin/papers/0511/0511018.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Finance with number 0511018.

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    Length: 10 pages
    Date of creation: 29 Nov 2005
    Date of revision:
    Handle: RePEc:wpa:wuwpfi:0511018

    Note: Type of Document - pdf; pages: 10
    Contact details of provider:
    Web page: http://128.118.178.162

    Related research

    Keywords: Defaultable Bond; Embedded Option; Partial Differential Equation; Finite Difference Method;

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