Modeling Term Structures of Defaultable Bond

Posted: 21 May 1999

See all articles by Darrell Duffie

Darrell Duffie

Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER); Canadian Derivatives Institute

Kenneth J. Singleton

Stanford University - Graduate School of Business

Abstract

This paper presents convenient reduced-form models of the valuation of contingent claims subject to default. A distinguishing feature of our approach is that losses at default are parameterized in terms of the fractional loss in market value. Under this assumption, and the assumption that default is an unpredictable event governed by a hazard-rate process, we show that many defaultable claims can be priced as if they are default-free by replacing the usual riskless discount rate by a default-adjusted short-rate process. This pricing framework is applied to callable and non-callable corporate bonds and a credit spread option. Additionally, we compare the pricing implications of models with fractional recovery of market value and fractional recovery of par upon default.

JEL Classification: G12

Suggested Citation

Duffie, James Darrell and Singleton, Kenneth J., Modeling Term Structures of Defaultable Bond. Available at SSRN: https://ssrn.com/abstract=161613

James Darrell Duffie

Stanford University - Graduate School of Business ( email )

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National Bureau of Economic Research (NBER)

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Canadian Derivatives Institute ( email )

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Kenneth J. Singleton (Contact Author)

Stanford University - Graduate School of Business ( email )

Knight Management Center
655 Knight Way
Stanford, CA 94305-7298
United States
650-723-5753 (Phone)

HOME PAGE: http://www.stanford.edu/~kenneths

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