Convertible Bonds with Market Risk and Credit Risk
by Mark Davis of the Imperial College (London), and
October 10, 1999
Abstract: The incorporation of credit risk in the valuation of convertible bonds has mostly been rather ad-hoc in the literature. Here a model is introduced that attempts a consistent treatment of equity and credit risk. It incorporates a Black-Scholes stock price (equity risk), Hull-White short rate (interest rate risk), and a hazard rate, depending on the asset price, which determines the probability of default (credit risk). The model can be calibrated to match the initial term structure of interest rates as well as the 'term structure of credit spreads'.
This paper is republished as Ch.25 in...