Computational Management Science

, Volume 9, Issue 4, pp 515–530

Credit spreads, endogenous bankruptcy and liquidity risk

Original Paper
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Abstract

In this paper, we consider a bond valuation model with both credit risk and liquidity risk to show that credit spreads are not negligible for short maturities. We adopt the structural approach to model credit risk, where the default triggering barrier is determined endogenously by maximizing equity value. As for liquidity risk, we assume that bondholders may encounter liquidity shocks during the lifetime of corporate bonds, and have to sell the bond immediately at the price, which is assumed to be a fraction of the price in a perfectly liquid market. Under this framework, we derive explicit expressions for corporate bond, firm value and bankruptcy trigger. Finally, numerical illustrations are presented.

Keywords

Liquidity risk Credit risk Credit spreads Endogenous bankruptcy 

Mathematics Subject Classification (2000)

60H30 91G40 91G50 

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Copyright information

© Springer-Verlag 2012

Authors and Affiliations

  1. 1.School of Mathematical SciencesNankai UniversityTianjinChina
  2. 2.School of BusinessNankai UniversityTianjinChina

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