Abstract
The effection of liquidity on the financial risk is becoming more and more important. Ignoring it the risk analysis would be in failure. This paper provides a default-risky debt valuation model, which assumes that market liquidity modelled by the intensity of default is driven by a continuous-time Markov chain. The model accounts for default probability with liquidity risk calibrated. A semimartingale representation of a liquid defaultable debt price is obtained. The illiquidity is modelled as exogenously specified stochastic reduction in the price of the debt, which adds more risks for the investors.
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