Pricing defaultable debt: some exact results
D. F. Wang (TD Bank, Univ. of Waterloo)
TL;DR
This paper extends Merton's model for pricing risky debt by incorporating the CIR interest rate model, providing exact closed-form solutions for the debt's price.
Contribution
It generalizes Merton's approach to include the CIR interest rate model and derives exact pricing formulas for risky debt.
Findings
Exact closed-form pricing formulas for risky debt under CIR interest rates
Generalization of Merton's model to more realistic interest rate dynamics
Analytical solutions facilitate better risk assessment of defaultable debt
Abstract
In this letter, I consider the issue of pricing risky debt by following Merton's approach. I generalize Merton's results to the case where the interest rate is modeled by the CIR term structure. Exact closed forms are provided for the risky debt's price.
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Taxonomy
TopicsStochastic processes and financial applications · Credit Risk and Financial Regulations · Economic theories and models