BFS 2002 |
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Contributed Talk |
Chi-fai Lo, C.H. Hui, H.C. Lee
This paper develops a three-factor
corporate bond valuation model that incorporates
a stochastic default barrier. The default
barrier is considered as the bond issuer's
liability. A corporate bond defaults when the
bond issuer's leverage ratio (liability-to-asset
ratio) increases above a predefined
default-triggering value. The payoff to the
bondholders in case of default is a constant
fraction of the value of a default-free security
with the same corporate bond face value. A
closed-form solution of the corporate bond price
is derived to obtain credit spreads. The
dynamics of the default barrier proposed in the
three-factor model is more general than that
proposed by Longstaff and Schwartz (1995) and
Saà-Requejo and Santa-Clara (1999). This model
is capable of producing quite diverse shapes of
the term structures of corporate credit spreads.
The numerical results show that credit spreads
exhibit complex relationships with the parameters
of the model.
http://www.phy.cuhk.edu.hk/~cflo/finance.html