Pricing Corporate Bonds with Interest Rates Following Double Square-Root Process
International Journal of Financial Engineering, Vol. 3, No. 3, (2016), 1650015 (31 pages)
31 Pages Posted: 7 Dec 2012 Last revised: 19 Nov 2016
Date Written: November 15, 2016
This paper develops a corporate bond pricing model following the structural approach in which the dynamics of the instantaneous risk-free interest rate are governed by a double square-root (DSR) process. Credit spreads generated from this pricing model depend explicitly upon the levels of interest rates via a nonlinear effect arising from a DSR process. Given a positive correlation between interest rates and leverage ratios, the credit spreads generated by this pricing model have a negative relationship with interest rates, that is consistent with empirical findings using bond market data over the period 2008-2013 when interest rates were low.
Keywords: Finance, Corporate bond pricing, Stochastic interest rate
JEL Classification: G13, G21, G28
Suggested Citation: Suggested Citation