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Defaultable Bonds via HKA

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  • Yuta Inoue
  • Takahiro Tsuchiya

Abstract

To construct a no-arbitrage defaultable bond market, we work on the state price density framework. Using the heat kernel approach (HKA for short) with the killing of a Markov process, we construct a single defaultable bond market that enables an explicit expression of a defaultable bond and credit spread under quadratic Gaussian settings. Some simulation results show that the model is not only tractable but realistic.

Suggested Citation

  • Yuta Inoue & Takahiro Tsuchiya, 2011. "Defaultable Bonds via HKA," Papers 1103.4541, arXiv.org.
    • Handle: RePEc:arx:papers:1103.4541
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    References listed on IDEAS

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    1. Jeffery D Amato & Eli M Remolona, 2003. "The credit spread puzzle," BIS Quarterly Review, Bank for International Settlements, December.
    2. Joanne Kennedy & Phil Hunt & Antoon Pelsser, 2000. "Markov-functional interest rate models," Finance and Stochastics, Springer, vol. 4(4), pages 391-408.
    3. Jirô Akahori & Takahiro Tsuchiya, 2006. "What is the Natural Scale for a Lévy Process in Modelling Term Structure of Interest Rates?," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 13(4), pages 299-313, December.
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