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J. Risk Financial Manag. 2018, 11(4), 87; https://doi.org/10.3390/jrfm11040087

On a New Corporate Bond Pricing Model with Potential Credit Rating Change and Stochastic Interest Rate

1
Department of Mathematics and Statistics, Washington State University, Pullman, WA 99164, USA
2
Department of Mathematics, Tongji University, Shanghai 200092, China
3
School of Statistics and Mathematics, Shanghai Lixin University of Accounting and Finance, Shanghai 201209, China
*
Author to whom correspondence should be addressed.
Received: 12 November 2018 / Accepted: 30 November 2018 / Published: 6 December 2018
(This article belongs to the Special Issue Corporate Debt)
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Abstract

In this paper, we consider a new corporate bond-pricing model with credit-rating migration risks and a stochastic interest rate. In the new model, the criterion for rating change is based on a predetermined ratio of the corporation’s total asset and debt. Moreover, the rating changes are allowed to happen a finite number of times during the life-span of the bond. The volatility of a corporate bond price may have a jump when a credit rating for the bond is changed. Moreover, the volatility of the bond is also assumed to depend on the interest rate. This new model improves the previous existing bond models in which the rating change is only allowed to occur once with an interest-dependent volatility or multi-ratings with constant interest rate. By using a Feynman-Kac formula, we obtain a free boundary problem. Global existence and uniqueness are established when the interest rate follows a Vasicek’s stochastic process. Calibration of the model parameters and some numerical calculations are shown. View Full-Text
Keywords: corporate bond-pricing model; multi credit rating migration; jump volatility; stochastic interest rate corporate bond-pricing model; multi credit rating migration; jump volatility; stochastic interest rate
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Yin, H.-M.; Liang, J.; Wu, Y. On a New Corporate Bond Pricing Model with Potential Credit Rating Change and Stochastic Interest Rate. J. Risk Financial Manag. 2018, 11, 87.

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