Indifference of Defaultable Bonds with Stochastic Intensity models
Regis Houssou, Olivier Besson
TL;DR
This paper investigates the pricing of defaultable bonds with stochastic default intensities, deriving HJB equations, solving them numerically, and analyzing how risk factors influence yield spreads.
Contribution
It introduces a finite difference approach to solve the HJB equations for stochastic intensity models and analyzes the impact of risk aversion and correlation on spreads.
Findings
Yield spreads are sensitive to default intensity dynamics.
Risk aversion influences bond pricing and spreads.
Correlation affects the behavior of spread curves.
Abstract
The utility-based pricing of defaultable bonds in the case of stochastic intensity models of default risk is discussed. The Hamilton-Jacobi- Bellman (HJB) equations for the value functions is derived. A finite difference method is used to solve this problem. The yield-spreads for both buyer and seller are extracted. The behaviour of the spread curve given the default intensity is analyzed. Finally the impacts of the risk aversion and the correlation coefficient are discussed.
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Taxonomy
TopicsCredit Risk and Financial Regulations · Stochastic processes and financial applications · Risk and Portfolio Optimization