Closed-form solutions for pricing credit-risky bonds and bond options

Abstract

This paper proposes closed-form solutions for pricing credit-risky discount bonds and their European call and put options in the intensity-based reduced-form framework, assuming the stochastic dynamics of both the risk-free interest rate and the credit-spread are driven by two correlated Ho–Lee models [T.S.Y. Ho, S.B. Lee, Term structure movements and pricing interest rates contingent claims, Journal of Finance 41 (5) (1986) 1011–1029]. The results are easily to implement, and require very few parameters which are directly implied from market data.