Under reduced form model, can other liabilities replace zero coupon bond?
Not quite, the reduced form model assumes that ONE of the liabilities is a zero coupon bond (plus it must be tradeable in a frictionless and arbitrage-free markets). Yes you can have other forms of liabilities but you need to have ONE zero coupon bond liability.
Yes it could be, based in Schweser’s notes book 4, Los 38f, page 94 " This is not restrictive assumption: other liabilities could be used in lieu of zero coupon bond"
The following is from curriculum:
“The first assumption requires only that one of the company’s liabilities, a zero-coupon bond, trades in frictionless and arbitrage-free markets. Reduced form models do not assume that the company’s assets trade. They also do not assume that the company’s remaining liabilities or even its equity trades. Other liabilities could be used in place of a zero-coupon bond.”
Cannot understand it. Its says other liabilities cannot trade, but it also says other liabilities could be used in place of a zero-coupon bond. If it cannot trade, how to generate the market value?