Abstract
This paper proposes a defaultable bonds pricing model extending the traditional spread process definition. The posited model is able to incorporate any potential cyclical, non-linear, or long-term process not fully captured by the stochastic behavior of the spot rate and the instantaneous default rate process. Under this framework, we analyze the empirical ability of our model to capture the spread dynamics of three different Investment-grade US Corporate bonds indexes. Our findings show that when compared to the Benchmark, our model improves the empirical performance reducing the yield spread mispricing by 35%, 37%, and 29% for the High grade, Upper medium grade, and Lower medium grade index, respectively.
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Notes
Note that, although \({\widetilde{W}}_{t}^0 \bot {\widetilde{W}}_{t}^1\), there is certain level of correlation between \(r_t\) and \(h_t\) coming from the term \(\beta r_t\) in equation (6)
As mentioned in Sect. 3.1, given the COVID outbreak and the impact on the market, we opt to implement the empirical application considering the period from 04-Jan, 2010 up to 31-Dec, 2019.
For the sake of brevity we only present UMG index. Similar figures are obtained for HG and LMG indexes.
For the sake of brevity we only present UMG index. Similar figures are obtained for HG and LMG indexes and are available upon request.
Obtained from the Board of Governors of the Federal Reserve System
Obtained from the Federal Reserve Bank of St. Louis
Obtained from Bloomberg
For the sake of brevity we only show the results obtained on Upper medium grade tranche. Similar results are obtained on High and Lower medium grade tranches.
Since VXIEF is available from Apr-2015 there are only 58 monthly observations
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Acknowledgements
The authors are very grateful to the editor Endre Boros and two anonymous referees for their truly helpful comments and suggestions over the previous versions of the paper. Federico Platania gratefully ackonowledge financial support by the grant SBPLY/19/180501/000172. The authors certify that there is no conflict of interest. All remaining errors are ours.
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Bazgour, T., Platania, F. A defaultable bond model with cyclical fluctuations in the spread process. Ann Oper Res 312, 647–672 (2022). https://doi.org/10.1007/s10479-021-04471-9
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DOI: https://doi.org/10.1007/s10479-021-04471-9