A valuation model of credit-rating linked coupon bond based on a structural model

摘要

A credit-linked coupon bond pays a coupon associated with its credit rating at the time of the coupon payment date, rather than an amount equal to the initially fixed coupon. The only existing corporate bond valuation model for credit-rating-triggered products was formulated by Jarrow et al. However, this model does not incorporate the fact that increases in the coupon payment resulting from downgrades may cause a further deterioration of credit ratings and of the likelihood that the company will be able to make future coupon payments. In this paper, we present a credit-linked coupon bond valuation model that considers this issue. Using a structural approach, we extend the classical model of Merton by introducing a threshold value corresponding to each credit rating, and a volatility of the company value process that depends on its credit rating. Given these extensions, our model is more flexible than the JLT model, and we are clearly able to capture the above effect via numerical simulations. Furthermore, from the perspective of practical implications, the JLT model tends to value credit-linked coupon bonds more cheaply than does our model when the initial credit rating is high, while the reverse is true for a low initial credit rating.