Empirical Pricing of Chinese Defaultable Corporate Bonds Based on the Incomplete Information Model

Li Ping,Wang Xiaoxu

doi:10.1155/2014/286739

Abstract

The default of Suntech Power made the year 2013 in China “the first year of default” of bond markets. People are also clearly aware of the default risk of corporate bonds and find that fair pricing for defaultable corporate bonds is very important. In this paper we first give the pricing model based on incomplete information, then empirically price the Chinese corporate bond “11 super JGBS” from Merton’s model, reduced-form model, and incomplete information model, respectively, and then compare the obtained prices with the real prices. Results show that all the three models can reflect the trend of bond prices, but the incomplete information model fits the real prices best. In addition, the default probability obtained from the incomplete information model can discriminate the credit quality of listed companies.

Highlights

Because of the subprime crisis and the European sovereign debt crisis, global economy has been seriously hit
The reduced-form model has the following characteristics: (1) it assumes that the market was complete which is accordant with the no-arbitrage assumption; (2) the credit risk can be obtained by the default probability; (3) the default is a random process; (4) the default recovery rate is an exogenous variable
We extend the incomplete information model by combining with the credit risk premium and redefined the pricing formula for defaultable corporate bonds

Summary

Introduction

Because of the subprime crisis and the European sovereign debt crisis, global economy has been seriously hit. The overall default probability of corporate bonds was 0.17 if in terms of the bond maturity and 0.12 if in terms of bond issuance This means that the year 2012 was a new starting point of Chinese bond market. There are three main models for defaultable bond pricing: the traditional structural model [1] and reduced-form model [2] and the emerging incomplete information model. We give a new pricing formula for defaultable corporate bonds by combining the incomplete information model with the credit risk premium based on default probability. We calculate the default probability and price for the Chinese corporate bond “11 super JGBS” from the three models: structural model, reduced-form model, and incomplete information model.

Traditional Pricing Models for Defaultable Bonds

The Incomplete Information Model Combined with Credit Risk Premium

Empirical Pricing

Conclusions