Corporate Bond Valuation with Both Expected and Unexpected Default
AbstractThis paper presents three variants of a tractable structural model in which default may take place both expectedly and unexpectedly. The model has the merit of predicting realistically high short term credit spreads. Closed form solutions are provided for corporate bonds (and default swaps) when interest rates are constant or stochastic and when the bond recovery value is exogenous or endogenous to the model. The analysis suggests that, in order for the observed short term yield spreads on high grade corporate bonds to be compensation for credit risk, bond holders must believe that a dramatic sudden plunge in the firm's assets value is possible, even if extremely unlikely.
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Bibliographic InfoPaper provided by Department of Economics, University of York in its series Discussion Papers with number 03/21.
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Corporate bond valuation: Structural model; Unexpected default; Short term credit spreads; endogenous bond recovery value; plunge of assets value;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-12-14 (All new papers)
- NEP-CFN-2003-12-14 (Corporate Finance)
- NEP-RMG-2003-12-14 (Risk Management)
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