Article
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Default Risk With Imperfect Information Under Regime-Switching Model
Version 1
: Received: 12 June 2024 / Approved: 12 June 2024 / Online: 12 June 2024 (17:53:02 CEST)
How to cite: Zarban, A. A.; Colwell, D.; Salopek, D. M. Default Risk With Imperfect Information Under Regime-Switching Model. Preprints 2024, 2024060833. https://doi.org/10.20944/preprints202406.0833.v1 Zarban, A. A.; Colwell, D.; Salopek, D. M. Default Risk With Imperfect Information Under Regime-Switching Model. Preprints 2024, 2024060833. https://doi.org/10.20944/preprints202406.0833.v1
Abstract
We propose a pricing formula for a defaultable zero-coupon bond with imperfect information under a regime-switching model using a structural form of credit risk modelling. While the value of the firm’s equity is observed continuously, we assume that the total value of the firm is only observed at discrete times, such as the dates of the release of the firm’s annual reports, or quarterly reports. This uncertainty about the true value of the firm results in credit spreads that do not approach zero as the debt approaches maturity, which is a problem with many structural models. The firm’s value is typically defined as its equity and debt; however, we consider the asset-to-equity ratio, an accounting ratio used to examine a firm’s financial well-being. A dependent regime-switching process models the components of this ratio, and the Markov chain represents the states of the economy. The main contribution is to study this problem when the dynamics of a firm’s assets have different parameters with regime changes.
Keywords
Risky Debt; Imperfect Information; Interest rate; Regime Switching
Subject
Computer Science and Mathematics, Probability and Statistics
Copyright: This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
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