Default risk, credit spreads and immunization strategies of corporate bonds

Abstract

This thesis provides two frameworks for valuing default risk of corporate debts and finds the determinants and the properties of credit spreads and suggests new duration measures and immunization strategies of them. Especially, this thesis focuses on analyzing the effect of the interest rate on the value of corporate bonds. Chapter II presents a probability-based valuation model of corporate bonds which adopts continuous time approach and generalized stochastic process of defaults to be able to imply various types of default rate. This chapter derives a new duration and risk measure and suggests immunization strategies of risky bonds using them. Immunization strategies vary with whether there is prior information about the stochastic process of defaults or not. Chapter III develops two-factor valuation models for corporate debts by adoption contingent-claims framework. Using the valuation frameworks the effects of the factors, the debt structure and the stability in cash flows of a firm, the interest rates, the recovery rate, etc., on credit spreads are examined. This chapter analyzes the effect of the interest rates on credit spreads in details. While the increase in the interest rate has an effect of decreasing credit spreads by decreasing debt ratio, it also has an effect of increasing credit spreads by increasing the volatility of the firm``s assets. The total effect of the interest rate on credit spreads is determined by the magnitude of two opposite direction effects. This chapter also derives another duration measure and suggests immunization strategies of risky bonds. The results of the thesis give us some meaningful implications for the properties of risky debts and furnish tools for managing risky bonds.