A Generalized Endogenous Grid Method for Default Risk Models

Abstract: We extend the endogenous grid method to default risk models, which is faster and more accurate than grid search. Our method is 4 to 27 times faster and provides a more accurate bond price function, resulting in substantial differences in the predictions of the canonical sovereign debt model. When applied to Arellano's (2008) model, our approach predicts a standard deviation of the interest rate spread one‐third lower and defaults 3 to 5 times less frequently than does the conventional approach. Finally, we demonstrate that our method is applicable to a broad class of default risk models by characterizing sufficient conditions.