I live in a country where no corporate bond market exists. We have govt. yield curves for 91-Day, 182-Day, 364-Day, 2-Year, 5-Year, 10-Year, 15-Year and 20-Year maturity buckets. We also have Overnight, 1-Month and 3-Month inter-bank borrowing rates. Now, if I want to simulate a yield curve which will include the premium for the market’s overall credit risk, how will I do that?
One solution can be to determine the credit risk premium in the 3-Month bucket by deducting the 91-Day Govt. T-bill rate from the 1-Month inter-bank borrowing rate and then to add this premium to all other maturity points in the govt. yield curve to generate the a yield curve incorporating the credit risk premium.
However, one problem with this approach is that the slope of the risk-free yield curve and the simulated yield curve will be the same, which should not be the case. The simulated yield curve should have a steeper curve in case the economy is in recession (or the credit environment is a bit shaky) and vice versa.
Now, how can I adjust for the slope of the simulated yield curve? Can anyone please help?