Integrating the risk and term structures of interest rates

Jean-Paul Décamps

The European Journal of Finance, 1996, vol. 2, issue 3, 219-238

Abstract: Merton (1974) analysed the risk structure of corporate bonds under the assumption of a flat term structure of interest rates. We clarify his results and extend them to the case of stochastic interest rates. As a consequence we deal simultaneously with interest rate risk and with default risk. We investigate the price of a corporate bond and the various measures of the riskness of a corporate bond proposed by Merton ((i) the Yield difference between the corporate bond and a default free bond with the same characteristics, (ii) the standard deviation of the rate of return of a corporate bond). We demonstrate and we explain why several of Merton's conclusions are no longer valid in a stochastic term structure framework.

Keywords: option pricing; term structure of interest rates; default risk; interest rate risk (search for similar items in EconPapers)
Date: 1996
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Working Paper: Integrating the Risk and Term Structure of Interest Rates (1992)
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DOI: 10.1080/13518479600000006

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