An Affine Structure Model with Considering the Negative Correlation between Default Probability and Recovery Rate

An affine structure model to price defaultable coupon bond was proposed in this paper. The model considers the negative correlation between default probability and the recovery rate. By constructing a characteristic function and solving the corresponding Riccati equations, the closed-form solution of the pricing model was gotten. The parameter sensitivity analysis indicates that the proposed model can produce abundant credit spread term structures and that the risk of recovery rate is certainly a systematic risk factor which can bring risk premium. At last, the empirical research selected four corporation bonds on Shanghai stock exchange to test the model. The results indicate that the recovery rates of these bonds are all very high and the hazard rates are all very low which are consistent with the real condition that these bonds are all high rating bonds. And the matching of market price and theoretical price demonstrates the validity of the model