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Generalizing Merton's approach of pricing risky debt: some closed-form results

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  • Wang, D.F

Abstract

In this work, I generalize Merton's approach of pricing risky debt to the case where the interest rate risk is modeled by the CIR term structure. Closed-form result for pricing the debt is given for the case where the firm value has non-zero correlation with the interest rate. This extends previous closed-form pricing formular of zero-correlation case to the generic one of non-zero correlation between the firm value and the interest rate.

Suggested Citation

  • Wang, D.F, 1999. "Generalizing Merton's approach of pricing risky debt: some closed-form results," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 265(1), pages 292-296.
    • Handle: RePEc:eee:phsmap:v:265:y:1999:i:1:p:292-296
    DOI: 10.1016/S0378-4371(98)00545-7
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    1. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
    2. Longstaff, Francis A & Schwartz, Eduardo S, 1995. "A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
    3. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    4. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    5. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    6. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 627-627, November.
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    Keywords

    Defaultable bond; CIR term structure;

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