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Default Risk in Asset Pricing

  • Pierre Mella-Barral
  • Pierre Tychon

This paper provides an analytical solution for the impact of default risk on the valuation of realistically intricate claims on time-dependent uncertain income streams. Its modular structure allows us to adjust the set of assumptions concerning the event of default to the specificity of the environment which surrounds the asset. The importance of such a flexibility is illustrated in the context of corporate debt, examining the simplest case of finite-lived coupon-paying corporate bonds with principal repayment at maturity. The magnitude of risk premia, as well as the term structure of credit spreads, are, not surprisingly, largely determined by the assumed default scenario.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp250.pdf
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp250.

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Date of creation: Oct 1996
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Handle: RePEc:fmg:fmgdps:dp250
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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  1. Leonardo Bartolini & Avinash K. Dixit, 1990. "Market Valuation of Illiquid Debt and Implications for Conflicts Among Creditors," IMF Working Papers 90/88, International Monetary Fund.
  2. Hayne E. Leland and Klaus Bjerre Toft., 1995. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Research Program in Finance Working Papers RPF-259, University of California at Berkeley.
  3. In Joon Kim & Krishna Ramaswamy & Suresh Sundaresan, 1993. "Does Default Risk in Coupons Affect the Valuation of Corporate Bonds?: A Contingent Claims Model," Financial Management, Financial Management Association, vol. 22(3), Fall.
  4. Fries,S. & Mella-Barral,P. & Perraudin,W.R.M., 1995. "Optimal Bank Reorganisation and the Fair Pricing of Deposit Garantees," Cambridge Working Papers in Economics 9417, Faculty of Economics, University of Cambridge.
  5. Brennan, Michael J & Schwartz, Edwardo S, 1978. "Corporate Income Taxes, Valuation, and the Problem of Optimal Capital Structure," The Journal of Business, University of Chicago Press, vol. 51(1), pages 103-14, January.
  6. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
  7. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
  8. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
  9. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
  10. Altman, Edward I, 1984. " A Further Empirical Investigation of the Bankruptcy Cost Question," Journal of Finance, American Finance Association, vol. 39(4), pages 1067-89, September.
  11. Hayri, Aydin, 2000. "Debt relief," Journal of International Economics, Elsevier, vol. 52(1), pages 137-152, October.
  12. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June.
  13. Alderson, Michael J. & Betker, Brian L., 1995. "Liquidation costs and capital structure," Journal of Financial Economics, Elsevier, vol. 39(1), pages 45-69, September.
  14. Pierre Mella-Barral, 1996. "The Dynamics of Corporate Debt forgiveness and Contract Renegotiation," FMG Discussion Papers dp230, Financial Markets Group.
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