The Pricing of Risky Bonds: Current Models and Future Directions

The modelling of credit risk, credit derivatives and non-hedgeable securities in general is currently in a poor state. Ideas from equity options theory have been adopted for credit risk, but have not been adapted for the peculiarities of this more complex world. This brief paper is a review and critique of current ideas and models, and includes suggestions for a more sophisticated realisitic and ultimately more sensible approach. The bibliography at the end should provide a useful source for the current state of the art.