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Title: Corporate bond valuation using Parasian options with endogenous recovery rates
Author: Yu, Lingzhi
Awarding Body: University of Manchester
Current Institution: University of Manchester
Date of Award: 2005
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Recovery rates are mostly treated as exogenous and constant in structural models. However, this assumption creates a number of valuation problems: default probability is disassociated from the recovery rate; recovery rate is uniform for all classes of bond; there is often a problem of discontinuity in payoff at expiration; and there is a possibility of a negative duration. This thesis adheres to the original Merton (1974) framework and proposes endogenously determined recovery rates, thus avoiding the above problems. This is achieved by modelling the process of firm value as the underlying asset of a ParAsian option, whose features can capture possible bankruptcy resolutions and violations of the absolute priority rule. Armed with this technique, a range of models are developed to value straight bonds, subordinated bonds, callable bonds as well as convertible bonds. Numerical results are obtained by means of the Crank-Nicolson finite-difference method, with parameter configurations adopted from Huang and Huang (2003). Investigation into credit spreads, bond values, durations and optimal exercise strategies, sheds light on the proposition of endogenous recovery rates as well as the ParAsian feature of corporate bonds. This research should have implications for fixed income investment and its hedging strategies.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available