An analytical model of risky yield curves

This paper proposes a multiperiod certainty equivalent model of present valuation that takes a dynamic approach to valuation, as opposed to a recursive approach employed traditionally in financial economics. Assuming a flat basic, or riskless, yield curve and risk‐averse investors, the model is used to examine the potential effects of default risk on the shape of the yield curve. The shape of the yield curve is shown to be directly related to the level and time pattern of default probabilities.