Modeling complex safety covenant of corporate risky bonds under the double exponential jump-diffusion process

Wen Chieh Chang, Han-Hsing Lee

Research output: Contribution to journalArticle

Abstract

This paper employs the structural approach for valuing corporate bonds under the double exponential jump-diffusion process, which offers much more flexibility in describing the empirical asset-return distribution than previous structural models. The authors extend the uniform sampling approach to develop a simple and efficient Monte Carlo simulation method for valuation of corporate risky bond with a complex safety covenant. Unlike the first passage-time model, our model incorporates the caution time setting which allows firm value to stay below the "caution default boundary" for a pre-specified time window. We further extend the model assuming an additional "immediate default boundary" in the safety covenant. These two models are used to illustrate how different assumptions of default boundaries and firm value process affect the possible credit spreads, default probabilities and recovery rates.

Original languageEnglish
Pages (from-to)193-207
Number of pages15
JournalInvestment Management and Financial Innovations
Volume10
Issue number2
StatePublished - 1 Jan 2013

Keywords

  • Caution time
  • Double exponential jump-diffusion process
  • Modified uniform sampling approach
  • Monte Carlo simulation
  • Parisian option
  • Safety covenant

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