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