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The Pricing Of Options On Credit-Sensitive Bonds


  • Sandra Peterson
  • Richard C. Stapleton


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.

Suggested Citation

  • Sandra Peterson & Richard C. Stapleton, 2003. "The Pricing Of Options On Credit-Sensitive Bonds," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 55(3), pages 178-193, July.
  • Handle: RePEc:sbr:abstra:v:55:y:2003:i:3:p:178-193

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    More about this item


    Credit Risk; Bonds; Options;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing


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