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Default risk modeling beyond the first-passage approximation: Position-dependent killing

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  • Yuri A. Katz
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    Abstract

    Diffusion in a linear potential in the presence of position-dependent killing is used to mimic a default process. Different assumptions regarding transport coefficients, initial conditions, and elasticity of the killing measure lead to diverse models of bankruptcy. One "stylized fact" is fundamental for our consideration: empirically default is a rather rare event, especially in the investment grade categories of credit ratings. Hence, the action of killing may be considered as a small parameter. In a number of special cases we derive closed-form expressions for the entire term structure of the cumulative probability of default, its hazard rate and intensity. Comparison with historical data on global corporate defaults confirms applicability of the model-independent perturbation method for companies in the investment grade categories of credit ratings and allows for

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    File URL: http://arxiv.org/pdf/1108.5098
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    Paper provided by arXiv.org in its series Papers with number 1108.5098.

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    Date of creation: Aug 2011
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    Handle: RePEc:arx:papers:1108.5098

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    Web page: http://arxiv.org/

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