The Pricing Of Options On Credit-Sensitive Bonds
We build a three-factor term-structure of interest rates model and use it to price corporate bonds. The first two factors allow the risk-free term structure to shift and tilt. The third factor generates a stochastic credit-risk premium. To implement the model, we apply the Peterson and Stapleton (2002) diffusion approximation methodology. The method approximates a correlated and lagged-dependent lognormal diffusion processes. We then price options on credit-sensitive bonds. The recombining log-binomial tree methodology allows the rapid computation of bond and option prices for binomial trees with up to forty periods.
Volume (Year): 55 (2003)
Issue (Month): 3 (July)
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