Credit risk pricing in a consumption‐based equilibrium framework with incomplete accounting information

Abstract We present a consumption‐based equilibrium framework for credit risk pricing based on the Epstein–Zin (EZ) preferences where default time is modeled as first hitting of boundary and bond investors have imperfect/partial information about firm value. The imperfect generated by underlying observed state variables noisy observation process In addition, consumption, volatility, value are to follow affine diffusion processes. Using EZ solution kernel, we provide an equivalent measure compute prices financial derivatives discounted values future payoffs given incomplete information. price zero‐coupon represented in terms solutions stochastic partial differential equation (SPDE) deterministic PDE; self‐contained proofs provided both this representation well‐posedness involved SPDE. Furthermore, SPDE numerically solved, which yields some insights into relationship between structure yield spreads model parameters.