EFFECT OF ASSET VALUE CORRELATION ON CREDIT-LINKED NOTE VALUES

2002 ◽  
Vol 05 (05) ◽  
pp. 455-478 ◽  
Author(s):  
C. H. HUI ◽  
C. F. LO
Keyword(s):  
Interest Rate ◽  
Credit Risk ◽  
Structural Model ◽  
Credit Spreads ◽  
Model Parameters ◽  
Risk Premiums ◽  
Closed Form Solutions ◽  
Asset Values ◽  
Dependent Model ◽  
Payoff Condition

This paper develops a simple model to study the credit risk premiums of credit-linked notes using the structural model. Closed-form solutions of credit risk premiums of the credit-linked notes derived from the model as functions of firm values and the short-term interest rate, with time-dependent model parameters governing the dynamics of the firm values and interest rate. The numerical results show that the credit spreads of a credit-linked note increase non-linearly with the decrease in the correlation between the asset values of the note issuer and the reference obligor when the final payoff condition depends on the asset values of the note issuer and the reference obligor. When the final payoff condition depends on the recovery rate of the note issuer upon default, the credit spreads could increase with the correlation. In addition, the term structures of model parameters and the correlations involving interest rate are clearly the important factors in determining the credit spreads of the notes.

scholarly journals A Theoretical Argument Why the t-Copula Explains Credit Risk Contagion Better than the Gaussian Copula

2010 ◽  
Vol 2010 ◽  
pp. 1-29 ◽  
Author(s):  
Didier Cossin ◽  
Henry Schellhorn ◽  
Nan Song ◽  
Satjaporn Tungsong
Keyword(s):  
Credit Risk ◽  
Network Effects ◽  
Structural Model ◽  
Copula Function ◽  
Credit Spreads ◽  
Gaussian Copula ◽  
Theoretical Argument ◽  
T Copula ◽  
Student’S T ◽  
Dependence Modelling

One of the key questions in credit dependence modelling is the specfication of the copula function linking the marginals of default variables. Copulae functions are important because they allow to decouple statistical inference into two parts: inference of the marginals and inference of the dependence. This is particularly important in the area of credit risk where information on dependence is scant. Whereas the techniques to estimate the parameters of the copula function seem to be fairly well established, the choice of the copula function is still an open problem. We find out by simulation that the t-copula naturally arises from a structural model of credit risk, proposed by Cossin and Schellhorn (2007). If revenues are linked by a Gaussian copula, we demonstrate that the t-copula provides a better fit to simulations than does a Gaussian copula. This is done under various specfications of the marginals and various configurations of the network. Beyond its quantitative importance, this result is qualitatively intriguing. Student's t-copulae induce fatter (joint) tails than Gaussian copulae ceteris paribus. On the other hand observed credit spreads have generally fatter joint tails than the ones implied by the Gaussian distribution. We thus provide a new statistical explanation why (i) credit spreads have fat joint tails, and (ii) financial crises are amplified by network effects.

CREDIT RISK MODELING WITH MISREPORTING AND INCOMPLETE INFORMATION

2009 ◽  
Vol 12 (01) ◽  
pp. 83-112 ◽  
Author(s):  
AGOSTINO CAPPONI ◽  
JAKŠA CVITANIĆ
Keyword(s):  
Credit Risk ◽  
Structural Model ◽  
Default Probability ◽  
Credit Spread ◽  
Model Estimation ◽  
Risk Modeling ◽  
Asset Values ◽  
Defaultable Securities ◽  
Risk Framework ◽  
Approximate Expressions

We propose a structural model for the valuation of defaultable securities of a firm which models the effect of deliberate misreporting done by insiders in the firm and unobserved by others. We derive exact formulas for equity and bond prices and approximate expressions for the conditional default probability, recovery rate, and credit spread under the proposed credit risk framework. We propose a novel estimation approach to structural model estimation which accounts for noisy observed asset values. We apply the proposed method to calibrate a simple version of our model to the case of Parmalat and show that the model is able to recover a certain amount of misreporting during the years of accounting irregularities.

A robust test of Merton's structural model for credit risk

2003 ◽  
Vol 6 (1) ◽  
pp. 39-58 ◽  
Author(s):  
Robert Jarrow ◽  
Donald van Deventer ◽  
Xiaoming Wang
Keyword(s):  
Credit Risk ◽  
Structural Model ◽  
Robust Test

Interest Rate Shocks and Credit Risk

2009 ◽  
Author(s):  
Carlos González-Aguado ◽  
Javier Suarez
Keyword(s):  
Interest Rate ◽  
Credit Risk ◽  
Interest Rate Shocks

scholarly journals Lie-Algebraic Approach for Pricing Zero-Coupon Bonds in Single-Factor Interest Rate Models

2013 ◽  
Vol 2013 ◽  
pp. 1-9 ◽  
Author(s):  
C. F. Lo
Keyword(s):  
Interest Rate ◽  
Algebraic Approach ◽  
Dynamical Symmetry ◽  
Bond Pricing ◽  
Model Parameters ◽  
Time Varying ◽  
Single Factor ◽  
Bond Price ◽  
Interest Rate Models ◽  
Root Model

The Lie-algebraic approach has been applied to solve the bond pricing problem in single-factor interest rate models. Four of the popular single-factor models, namely, the Vasicek model, Cox-Ingersoll-Ross model, double square-root model, and Ahn-Gao model, are investigated. By exploiting the dynamical symmetry of their bond pricing equations, analytical closed-form pricing formulae can be derived in a straightfoward manner. Time-varying model parameters could also be incorporated into the derivation of the bond price formulae, and this has the added advantage of allowing yield curves to be fitted. Furthermore, the Lie-algebraic approach can be easily extended to formulate new analytically tractable single-factor interest rate models.

scholarly journals HOLDER-EXTENDIBLE EUROPEAN OPTION: CORRECTIONS AND EXTENSIONS

2015 ◽  
Vol 56 (4) ◽  
pp. 359-372 ◽  
Author(s):  
PAVEL V. SHEVCHENKO
Keyword(s):  
Brownian Motion ◽  
Interest Rate ◽  
Real Life ◽  
Option Price ◽  
Geometric Brownian Motion ◽  
Fixed Amount ◽  
Underlying Asset ◽  
Closed Form Solutions ◽  
Pricing Options ◽  
Interest Rate Volatility

Financial contracts with options that allow the holder to extend the contract maturity by paying an additional fixed amount have found many applications in finance. Closed-form solutions for the price of these options have appeared in the literature for the case when the contract for the underlying asset follows a geometric Brownian motion with constant interest rate, volatility and nonnegative dividend yield. In this paper, option price is derived for the case of the underlying asset that follows a geometric Brownian motion with time-dependent drift and volatility, which is more important for real life applications. The option price formulae are derived for the case of a drift that includes nonnegative or negative dividend. The latter yields a solution type that is new to the literature. A negative dividend corresponds to a negative foreign interest rate for foreign exchange options, or storage costs for commodity options. It may also appear in pricing options with transaction costs or real options, where the drift is larger than the interest rate.

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