Jump Diffusion Models for Risky Debts: Quality Spread Differentials

Hoi Ying Wong () and Yue Kuen Kwok ()
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Hoi Ying Wong: Department of Statistics, Chinese University of Hong Kong, Shatin, Hong Kong, China
Yue Kuen Kwok: Department of Mathematics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China

International Journal of Theoretical and Applied Finance (IJTAF), 2003, vol. 06, issue 06, 655-662

Abstract: The quality spread differential is defined to be the difference between the default premiums demanded for fixed rate and floating rate risky debts. The risky debt model based on Merton's firm value approach is used to examine the behaviors of the quality spread differential of fixed rate and floating rate debts. We extend earlier result by adopting Geometric Brownian diffusion process with jumps for the underlying firm value process of the debt issuer. Closed form formulas are obtained for the default premiums for risky debts. The impact of the jumps on the fixed-floating spread differential is examined.

Keywords: Risky debts; jump diffusion process; default premiums; quality spread differential (search for similar items in EconPapers)
Date: 2003
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DOI: 10.1142/S0219024903002158

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