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Stochastic Volatility Effects on Defaultable Bonds

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Author Info

  • Jean-Pierre Fouque
  • Ronnie Sircar
  • Knut Sølna
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    Abstract

    This paper studies the effect of introducing stochastic volatility in the first-passage structural approach to default risk. The impact of volatility time scales on the yield spread curve is analyzed. In particular it is shown that the presence of a short time scale in the volatility raises the yield spreads at short maturities. It is argued that combining first passage default modelling with multiscale stochastic volatility produces more realistic yield spreads. Moreover, this framework enables the use of perturbation techniques to derive explicit approximations which facilitate the complicated issue of calibration of parameters.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/13504860600563127
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    Bibliographic Info

    Article provided by Taylor and Francis Journals in its journal Applied Mathematical Finance.

    Volume (Year): 13 (2006)
    Issue (Month): 3 ()
    Pages: 215-244
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    Handle: RePEc:taf:apmtfi:v:13:y:2006:i:3:p:215-244

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    Related research

    Keywords: First-passage structural approach; stochastic volatility; time scales; yield spreads; calibration;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
    2. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-64, May.
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    Cited by:
    1. Masaaki Fukasawa, 2011. "Asymptotic analysis for stochastic volatility: martingale expansion," Finance and Stochastics, Springer, vol. 15(4), pages 635-654, December.

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