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Jump Diffusion Models for Risky Debts: Quality Spread Differentials

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  • Hoi Ying Wong

    (Department of Statistics, Chinese University of Hong Kong, Shatin, Hong Kong, China)

  • Yue Kuen Kwok

    (Department of Mathematics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China)

Abstract

The quality spread differential is defined to be the difference between the default premiums demanded for fixed rate and floating rate risky debts. The risky debt model based on Merton's firm value approach is used to examine the behaviors of the quality spread differential of fixed rate and floating rate debts. We extend earlier result by adopting Geometric Brownian diffusion process with jumps for the underlying firm value process of the debt issuer. Closed form formulas are obtained for the default premiums for risky debts. The impact of the jumps on the fixed-floating spread differential is examined.

Suggested Citation

  • Hoi Ying Wong & Yue Kuen Kwok, 2003. "Jump Diffusion Models for Risky Debts: Quality Spread Differentials," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 6(06), pages 655-662.
    • Handle: RePEc:wsi:ijtafx:v:06:y:2003:i:06:n:s0219024903002158
    DOI: 10.1142/S0219024903002158
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    References listed on IDEAS

    as
    1. Chunsheng Zhou, 1997. "A jump-diffusion approach to modeling credit risk and valuing defaultable securities," Finance and Economics Discussion Series 1997-15, Board of Governors of the Federal Reserve System (U.S.).
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