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Defaultable Puttable/Callable Bond Valuation: A 3D Finite Difference Model

Author

Listed:
  • David Wang

    (Hsuan Chuang University, Taiwan)

  • Heng-Chih Chou

    (Ming Chuan University, Taiwan)

Abstract

This paper presents a 3D model for pricing defaultable bonds with embedded put/call options. The pricing model incorporates three essential ingredients in the pricing of defaultable bonds: stochastic interest rate, stochastic default risk, and put/call provision. Both the stochastic interest rate and the stochastic default risk are modeled as a square-root diffusion process. The default risk process is allowed to be correlated with the default-free term structure. The put/call provision is modeled as a constraint on the value of the bond in the finite difference scheme. This paper can provide new insight for future research on defaultable bond pricing models.

Suggested Citation

  • David Wang & Heng-Chih Chou, 2005. "Defaultable Puttable/Callable Bond Valuation: A 3D Finite Difference Model," Finance 0511018, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0511018
    Note: Type of Document - pdf; pages: 10
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    More about this item

    Keywords

    Defaultable Bond; Embedded Option; Partial Differential Equation; Finite Difference Method;

    JEL classification:

    • G - Financial Economics

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