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I have a question concerning pricing of a callable floating rate note (FRN). I have not found a lot of literature concerning callable FRNs (although a lot for callable bonds).

With my understanding, modelling the short rate is no longer relevant here (as would be the case for a callable bond) because interest rate movements do not dictate whether the bond will be called but actually the credit quality of the issuer:

ie. if the bond was issued with an issue spread of 100bps (ie. the FRN pays LIBOR+100bps and that 100bps represents the issuer's inferior credit quality over members of the interbank market) but over the course of the life of the bond the issuer's credit quality increases which is revealed in a lower trading spread/par floater spread of say 80bps then, if the strike price of the call was set at par say (ie. 100bps) then the bond would be called.

How should one go about modelling the credit quality of the issuer then? Does anybody know of some resources they advise looking at or a better approach to pricing this in general?

All help very much appreciated

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