This is a case study on the credit risk models, introduced by Cetin et al. (2004) and Guo et al. (2009). Empirical analyses are focused on the pricing of zero-coupon bonds issued by two US industrial companies, the Coca-Cola Company and PepsiCo Inc. Applying market observed information, simulations of some related variables are performed, and then the future zero-coupon bond prices for each discussed model are generated. The results indicate that during the financial tsunami influence period, due to the fact that the former model, i.e., Jarrow04, considers bond publisher’s cash reserves and immediately responds to market information, better predictions are obtained from it. However, in the period after the financial crisis, the latter model, i.e., Jarrow09, performs better for pricing a long-term zero-coupon bond, while for a short-term bond, the former performs slightly better.

In recent decades, literature on credit risk measurements has been dramatically and extensively discussed in academia and industry. The recent global financial crisis, which has caused bankruptcy of some famous companies, once again highlights the urgency on the credit risk predictions. In particular, the default risk of corporations is the major risk of banks and financial institutions. Effectively joining in public information to predict the probability of credit crisis of enterprises, has attracted the attention of recent financial research. Innovative credit risk models have widely used mathematical tools, statistical analysis and information technology to imitate market conditions. According to model structures, two major categories—structural form models and reduced form models—are classified.

Merton (1974) first proposed a structural model to price zero-coupon bonds, assuming that the dynamic process of firm’s assets follows the lognormal distribution. The bond prices were subject to fluctuations of the firm’s asset value. The default event happened when firm’s assets were less than liabilities. In order to measure a firm’s default risk, a structural model is mainly established by the firm’s capital, including assets, liabilities and equity. An essential advantage of the model is that the model construction contains meaningful economic and financial concept. However, the firm’s asset value and liabilities were difficult to measure via public information. Longstaff and Schwartz (1995) investigated risky corporate debt that incorporates both default and interest rate risk. They found that the correlation between default risk and the interest rate has a significant negative effect on the properties of the credit spread.

Financial Risk Management Journal, A Case Study, Reduced Form Credit Risk Models, Literature Review, Jarrow04 Model, Jarrow09 Model, Background of the Empirical Analysis, Data Description, Parameter Estimation, Interest Rate Model, Pricing Zero-Coupon Bonds, Comparison of Forecasts.