Abstract
This paper presents a regime-switching normal tempered stable (NTS) firm value model for pricing default risk, based on an N-state continuous Markov chain process and an underlying NTS process. The derived regime switching characteristic function enables closed-form expressions for corporate bond credit spreads, with the model’s innovation arising from substituting the characteristic function of the existing NTS firm value model. This approach is assumed to capture hidden factors affecting default risk pricing. Calibration for the term structure of US corporate industrial credit spread demonstrates the model’s superior fit across all credit ratings compared to NTS and Merton firm value models.
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