Abstract:

A pricing model of defaultable bond considering the liquidity risk is proposed according to the empirical literature concerning the credit spread puzzle.This model separates default risk and the liquidity risk involved in bond prices,thus resulting in a liquidity risk-adjusted credit default swap pricing.As the disturbance from the liquidity risk is eliminated,the pricing of the credit default swap with great accuracy is implemented.Meanwhile,the default strength parameters with and without liquidity risk are respectively considered according to the data from Chinese corporate bond market,and the corresponding credit default swap prices are calculated.The results indi-cate that the neglect of liquidity risk will results in the overestimation of default probability of high-rated bonds,especially those with short maturities,thus further resulting in an overestimation of initial credit default swap prices

Key words: liquidity risk, defauhable bond, credit default swap, random system, pricing