Bond Pricing with Default Risk
We price corporate debt from a structural model of ï¬ rm default. We assume that the capital market brings about eï¬ƒcient ï¬ rm default when the continuation value of the ï¬ rm falls below the value it would have after bankruptcy restructuring. This characterization of default makes the model more tractable and parsimonious than the existing structural models. The model can be applied in conjunction with a broad range of default-free interest rate models to price corporate bonds. Closed-form corporate bond prices are derived for various parametric examples. The term structures of yield spreads and durations predicted by our model are consistent with the empirical literature. We illustrate the empirical performance of the model by pricing selected corporate bonds with varied credit ratings.
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