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Estimating the Price of Default Risk

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  • Duffee, Gregory R

Abstract

A firm's instantaneous probability of default is modeled as a translated square-root diffusion process modified to allow the process to be correlated with default-free interest rates. The parameters of the process are estimated for 161 firms. An extended Kalman filter approach is used that incorporates both the time-series and cross-sectional (term structure) properties of the individual firms' bond prices. The model is reasonably successful at fitting corporate bond yields, while key features of the term structures of yield spreads are captured in the signs and magnitudes of the resulting parameter estimates. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Duffee, Gregory R, 1999. "Estimating the Price of Default Risk," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 197-226.
  • Handle: RePEc:oup:rfinst:v:12:y:1999:i:1:p:197-226
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    References listed on IDEAS

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    1. Gregory R. Duffee, 1996. "Treasury yields and corporate bond yield spreads: an empirical analysis," Finance and Economics Discussion Series 96-20, Board of Governors of the Federal Reserve System (U.S.).
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    8. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453, World Scientific Publishing Co. Pte. Ltd..
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    12. Gregory R. Duffee, "undated". "Treasury Yields and Corporate Bond Yield Spreads: An Empirical Analysis," Finance and Economics Discussion Series 1996-20, Board of Governors of the Federal Reserve System (U.S.), revised 10 Dec 2019.
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