New model reveals correlation between default risk and interest rates in debt valuation.
The article presents a simple method to value risky corporate debt considering default and interest rate risks. The researchers developed formulas for valuing fixed and floating rate debt, revealing insights on pricing and hedging debt securities. They discovered that the correlation between default risk and interest rates affects credit spreads significantly. Analysis of Moody's data showed that credit spreads decrease as interest rates rise, and the duration of risky bonds depends on the correlation with interest rates.