Pricing of Defaultable Bonds with Log-Normal Spread: Development of the Model and an Application to Argentinean and Brazilian Bonds During the Argentine Crisis

Authors: Estrada, Mariano¹; Cortina, Elsa²; FontÁn, Constantino³; Fiori, Javier⁴

Source: Review of Derivatives Research, Volume 8, Number 1, June 2005 , pp. 49-60(12)

Publisher: Springer

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Abstract:

In this paper we describe a two-factor model for a defaultable discount bond, assuming log-normal dynamics with bounded volatility for the instantaneous short rate spread. Under some simplified hypothesis, we obtain an explicit barrier-type solution for zero recovery and constant recovery. We also present a numerical application for Argentinean and Brazilian Sovereign Bonds during the default crisis of Argentina.

Keywords: credit risk; defaultable bonds; log-normal spread

Document Type: Research article

DOI: http://dx.doi.org/10.1007/s11147-005-1007-8

Affiliations: 1: Superintendencia de AFJP, Tucumán 500, (1049), Buenos Aires, Argentina, Email: mcane@safjp.gov.ar 2: Instituto Argentino de Matemática (CONICET), Saavedra 15, 3er. piso, (1083), Buenos Aires, Argentina, Email: elsa_iam@fibertel.com.ar 3: Instituto de Física del Plasma (CONICET), Facultad de Ciencias Exactas y Naturales, Universidad de Buenos Aires, Ciudad Universitaria, Pabellón 1, (1428), Buenos Aires, Argentina, Email: ferro@tinfip.lfp.uba.ar 4: Universidad de San Andrés, Vito Dumas 284, 1644, Victoria, Buenos Aires, Argentina, Email: javier.di.fiori@morganstanley.com

Publication date: 2005-06-01