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Multiple Ratings Model of Defaultable Term Structure

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  • Tomasz R. Bielecki
  • Marek Rutkowski
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    Abstract

    A new approach to modeling credit risk, to valuation of defaultable debt and to pricing of credit derivatives is developed. Our approach, based on the Heath, Jarrow, and Morton (1992) methodology, uses the available information about the credit spreads combined with the available information about the recovery rates to model the intensities of credit migrations between various credit ratings classes. This results in a conditionally Markovian model of credit risk. We then combine our model of credit risk with a model of interest rate risk in order to derive an arbitrage-free model of defaultable bonds. As expected, the market price processes of interest rate risk and credit risk provide a natural connection between the actual and the martingale probabilities. Copyright Blackwell Publishers, Inc..

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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal Mathematical Finance.

    Volume (Year): 10 (2000)
    Issue (Month): 2 ()
    Pages: 125-139

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    Handle: RePEc:bla:mathfi:v:10:y:2000:i:2:p:125-139

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    Web page: http://www.blackwellpublishing.com/journal.asp?ref=0960-1627

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    Cited by:
    1. Monfort, A. & Renne, J-P., 2011. "Default, liquidity and crises: an econometric framework," Working papers 340, Banque de France.
    2. Acharya, Viral V & Das, Sanjiv Ranjan & Sundaram, Rangarajan K, 2002. "Pricing Credit Derivatives with Rating Transitions," CEPR Discussion Papers 3329, C.E.P.R. Discussion Papers.
    3. repec:wyi:journl:002109 is not listed on IDEAS
    4. Batten, Jonathan & Hogan, Warren, 2002. "A perspective on credit derivatives," International Review of Financial Analysis, Elsevier, vol. 11(3), pages 251-278.
    5. Dai, Qiang & Singleton, Kenneth J., 2003. "Fixed-income pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 20, pages 1207-1246 Elsevier.
    6. Wei, Jason Z., 2003. "A multi-factor, credit migration model for sovereign and corporate debts," Journal of International Money and Finance, Elsevier, vol. 22(5), pages 709-735, October.

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