Defaultable Puttable/Callable Bond Valuation: A 3D Finite Difference Model
David Wang and
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David Wang: Hsuan Chuang University, Taiwan
Heng-Chih Chou: Ming Chuan University, Taiwan
Finance from EconWPA
This paper presents a 3D model for pricing defaultable bonds with embedded put/call options. The pricing model incorporates three essential ingredients in the pricing of defaultable bonds: stochastic interest rate, stochastic default risk, and put/call provision. Both the stochastic interest rate and the stochastic default risk are modeled as a square-root diffusion process. The default risk process is allowed to be correlated with the default-free term structure. The put/call provision is modeled as a constraint on the value of the bond in the finite difference scheme. This paper can provide new insight for future research on defaultable bond pricing models.
Keywords: Defaultable Bond; Embedded Option; Partial Differential Equation; Finite Difference Method (search for similar items in EconPapers)
JEL-codes: G (search for similar items in EconPapers)
Note: Type of Document - pdf; pages: 10
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:0511018
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