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Pricing of cabllable corporate bond
Dear friends,I have an question on how to calculate the value of callable corpoarte bond. My company has a software which can simulate the binominial tree of the bond. But I checked the calculation, the nodes were calculated by the change of interest rate only, the credit spread remained constant. I felt that the correct simulation should consider both interest rate and credit spread volatility at the same time.Please advise whether my understanding is correct or not.Thanks
Pricing of cabllable corporate bond
Your understanding is correct. You need to model both the risk-free interest rate and the default risk / credit spread of the bond issuer.
Pricing of cabllable corporate bond
You should model the rate and the spread/default risk and nowadays most people do but, conventionally, one would often have modeled callable corporates by just simulating the rate and solving for the constant spread (option-adjusted spread) you have to add to get the market price of the bond.
Pricing of cabllable corporate bond
what do most people assume for credit spread/interest rate correlation at this point?
Pricing of cabllable corporate bond
In my company system, it only calculate the simulation by considering interest rate movement only, assuming spread constant. I think the most easy and convienent way is to simulate the value by price (which is a combine of interest rate and spread change). And the correlation between the interest rate and spread movement is embedded in the price. But my system can't do that, it only can simulate the value by constant spread.
Pricing of cabllable corporate bond
In my company system, it only calculate the simulation by considering interest rate movement only, assuming spread constant. I think the most easy and convienent way is to simulate the value by price (which is a combine of interest rate and spread change). And the correlation between the interest rate and spread movement is embedded in the price. But my system can't do that, it only can simulate the value by constant spread.