PPT Slide

Numerical example

Take d = 0.32

The default-free

spot interest rate

process is determined

by some interest

rate model.

r(0) = 5.274%

r(1)u=6.359%, P0(1,2)u=0.9384

r(1)d=5.206%, P0(1,2)d=0.9493

p0 = 0.5

Using v1(0, 1) = P0(0, 1)[lm0d + (1 - lm0)], we obtain

lm0 = 0.01.

From v1(0, 2) = P0(0, 2) {lm0d + (1 – lm0)[lm1d + (1 - lm1)]},

we obtain lm1 = 0.03.