Probability of default implied by spot rates

A brief look at using spot rates in the term structure to infer the probability of default (PD) on the risky bond. For FRM candidates, this is based on Saunders 11-4. Please note this is a simple model: it works by assuming the investor is indifferent to bond with identical expected returns (i.e., the risky bonds expected return is its probability-adjusted promised return) but does not account for differences in risk. That is, it assumes the investor is not risk averse and therefore it gives risk-neutral probabilities.

Category:

Education

Tags:

• Finance
• bonds
• interest
• rate
• credit
• risk
• probability
• default

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