The Pricing Of Options On Credit-Sensitive Bonds

Sandra Peterson and Richard C. Stapleton

Schmalenbach Business Review (sbr), 2003, vol. 55, issue 3, 178-193

Abstract: We build a three-factor term-structure of interest rates model and use it to price corporate bonds. The first two factors allow the risk-free term structure to shift and tilt. The third factor generates a stochastic credit-risk premium. To implement the model, we apply the Peterson and Stapleton (2002) diffusion approximation methodology. The method approximates a correlated and lagged-dependent lognormal diffusion processes. We then price options on credit-sensitive bonds. The recombining log-binomial tree methodology allows the rapid computation of bond and option prices for binomial trees with up to forty periods.

Keywords: Credit Risk; Bonds; Options (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2003
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Citations: View citations in EconPapers (1)

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