Valuation Model of Defaultable Bond Values in Emerging Markets

16 Pages Posted: 2 May 2007

See all articles by Cho-Hoi Hui

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

Chi-Fai Lo

The Chinese University of Hong Kong

Abstract

This paper develops a model to value defaultable bonds in emerging markets. Default occurs when some signaling process hits a pre-defined default barrier. The signaling variable is considered to be some macro-economic variables such as foreign exchange rates. The dynamics of the default barrier depends on the volatility and the drift of the signaling variable. We derive a closed-form solution of the defaultable bond price from the model as a function of a signaling variable and a short-term interest rate. The numerical results show that the model values generated by using foreign exchange rates as the signaling variables can broadly track the market credit spreads of defaultable bonds in South Korea and Brazil. Given an expected level of the foreign exchange rate, defaultable bond values under stressed market situation can be obtained.

Keywords: risky bonds, credit risk, emerging markets, stress tests

JEL Classification: G21, G28, G13

Suggested Citation

Hui, Cho-Hoi and Lo, Chi-Fai, Valuation Model of Defaultable Bond Values in Emerging Markets. Asia-Pacific Financial Markets, Vol. 9, No. 1, pp. 45-60, 2002. Available at SSRN: https://ssrn.com/abstract=983842

Cho-Hoi Hui (Contact Author)

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

Chi-Fai Lo

The Chinese University of Hong Kong ( email )

Department of Physics
Shatin, N.T., Hong Kong
China

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