Pricing defaultable bonds: a middle-way approach between structural and reduced-form models

摘要

In this paper we present a valuation model that combines features of both the structural and reduced-form approaches for modelling default risk. We maintain the cause and effect or 'structural' definition of default and assume that default is triggered when a state variable reaches a default boundary. However. in our model. the state variable is not interpreted as the assets of the firm. but as a latent variable signalling the credit quality of the firm. Default in our model can also occur according to a doubly stochastic hazard rate. The hazard rate is a linear function of the state variable and the interest rate. We Use the Cox et al. (A theory of the term structure of interest rates. Econometrics. 1985. 53(2). 38S-407) term structure model to preclude the possibility of negative probabilities of default. We also horse race the proposed valuation model against structural and reduced-form default risky bond pricing models and find that term structures of credit spreads generated using the middle-way approach are snore in line with empirical observations.