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Asian Review of Financial Research, Vol.15, No.2.
pp.297~329
vol.15 no.2
pp.297~329
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This paper presents a pricing formulas of the defaultable bond under the reduced-form model. The market value of the firm ¡¯s asset, as the first state variable, is assumed to follow the jump-diffusion process which reflects the sudden changes of the firm value, and to exhibit a mean reverting. A new probability measure, ¡°default risk adjusted forward measure", is defined and used to price the FRN. This new measure has a strong advantage of calculating interest rate derivatives with the default risk. The model is also extended to price the defaultable bond with the counterparty default risk.
This paper presents a pricing formulas of the defaultable bond under the reduced-form model. The market value of the firm ¡¯s asset, as the first state variable, is assumed to follow the jump-diffusion process which reflects the sudden changes of the firm value, and to exhibit a mean reverting. A new probability measure, ¡°default risk adjusted forward measure", is defined and used to price the FRN. This new measure has a strong advantage of calculating interest rate derivatives with the default risk. The model is also extended to price the defaultable bond with the counterparty default risk.