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Pricing credit derivatives under stochastic recovery in a hybrid model

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  • Stephan Höcht
  • Rudi Zagst

Abstract

In this article, a framework for the joint modelling of default and recovery risk is presented. The model accounts for typical characteristics known from empirical studies, e.g. negative correlation between recovery‐rate process and default intensity, as well as between default intensity and state of the economy, and a positive dependence of recovery rates on the economic environment. Within this framework analytically tractable pricing formulas for credit derivatives are derived. The stochastic model for the recovery process allows for the pricing of credit derivatives with payoffs that are directly linked to the recovery rate at default, e.g. recovery locks. Copyright © 2009 John Wiley & Sons, Ltd.

Suggested Citation

  • Stephan Höcht & Rudi Zagst, 2010. "Pricing credit derivatives under stochastic recovery in a hybrid model," Applied Stochastic Models in Business and Industry, John Wiley & Sons, vol. 26(3), pages 254-276, May.
    • Handle: RePEc:wly:apsmbi:v:26:y:2010:i:3:p:254-276
    DOI: 10.1002/asmb.792
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    Cited by:

    1. Thamayanthi Chellathurai, 2017. "Probability Density Of Recovery Rate Given Default Of A Firm’S Debt And Its Constituent Tranches," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(04), pages 1-34, June.

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