Abstract

We carefully study the transmission mechanisms from default-free rates to corporate bond prices within structural models of endogenous default risk. The transmission critically depends on whether the model is value-based or cashflow-based, on the assumptions made for the drift of the state variable, and on the way the residual value at default is shared among bondholders. The recovery assumption is crucial: Recovery of Face Value, which entails receiving the same share of residual value at default regardless of the remaining maturity, greatly helps explaining the empirical evidence on bond-price sensitivities to interest rates.
Original languageEnglish
Pages (from-to)1148-1171
Number of pages24
JournalEuropean Journal of Operational Research
Volume283
DOIs
Publication statusPublished - 2020

Keywords

  • Bond risk management
  • Duration
  • Finance
  • Recovery forms
  • Structural endogenous default risk

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