Semi-analytical pricing of defaultable bonds in a signaling jump-default model

Lara Cathcart and Lina El-Jahel

Abstract

ABSTRACT

This paper derives analytical solutions for defaultable bonds when the underlying interest rates follow a mean-reverting square-root process. The default event occurs in an expected or an unexpected manner when the value of a signaling process that represents the credit quality of the issuer reaches a certain lower threshold or at the first jump time of a hazard-rate process, respectively. The hazard rate is dependent on the default-free interest rate. The model generates term structures of credit spreads which are consistent with empirical observations.