A Dynamic Equilibrium Q Probability Measure for Poisson Yield Spreads – Review of European Corporate Bonds

Abstract

This paper presents a new model for term risk, yield curve, and credit risk in spreads in a unified approach. The originality lies in the structuring of the Poisson stochastic of risk in a form suitable for finding the differential equation for the yield curve and its spreads as the Poisson Yield Spread Model (PYSM). A new P to Q change in measure is found for the purpose of parameterizing the stochastic component of the yield curve, based on a frequency specified version of the single event Poisson process. The PYSM determines the behaviour of discount rates and yield spreads over EU debt risk extremes.

Keywords: yield term structure, arbitrage-free Poisson, forwards-spread model, interest rate AR(1) theory

JEL Classification: C32, D53, E43, G13