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Valuation of default sensitive claims under imperfect information

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  • Jeanblanc, Monique
  • Geman, Hélyette
  • Coculescu, Délia
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    Abstract

    We propose an evaluation method for financial assets subject to default risk, when investors face imperfect information about the state variable triggering the default. The model we propose generalizes the one by Duffie and Lando (2001) in the following way:(i)it incorporates informational noise in continuous time, (ii) it respects the (H) hypothesis, (iii) it precludes arbitrage from insiders. The model is sufficiently general to encompass a large class of structural models. In this setting we show that the default time is totally inaccessible in the market’s filtration and derive the martingale hazard process. Finally, we provide pricing formulas for default-sensitive claims and illustrate with particular examples the shapes of the credit spreads and the conditional default probabilities. An important feature of the conditional default probabilities is they are non Markovian. This might shed some light on observed phenomena such as the ”rating momentum”.

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    File URL: http://basepub.dauphine.fr/xmlui/bitstream/123456789/2191/2/Delia.pdf
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    Bibliographic Info

    Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/2191.

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    Date of creation: Apr 2006
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    Handle: RePEc:dau:papers:123456789/2191

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    Related research

    Keywords: hybrid models; default sensitive claims;

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    References

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    1. Yu, Fan, 2005. "Accounting transparency and the term structure of credit spreads," Journal of Financial Economics, Elsevier, vol. 75(1), pages 53-84, January.
    2. R. J. Elliott & M. Jeanblanc & M. Yor, 2000. "On Models of Default Risk," Mathematical Finance, Wiley Blackwell, vol. 10(2), pages 179-195.
    3. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-52, September.
    4. Umut Cetin & Robert Jarrow & Philip Protter & Yildiray Yildirim, 2004. "Modeling Credit Risk with Partial Information," Papers math/0407060, arXiv.org.
    5. Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, vol. 56(5), pages 1765-1799, October.
    6. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
    7. Pierre Mella-Barral & William R M Perraudin, 1993. "Strategic Debt Service," CEPR Financial Markets Paper 0039, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
    8. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    9. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-25, July.
    10. Bernard, Carole & Le Courtois, Olivier & Quittard-Pinon, Francois, 2005. "Market value of life insurance contracts under stochastic interest rates and default risk," Insurance: Mathematics and Economics, Elsevier, vol. 36(3), pages 499-516, June.
    11. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
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    Cited by:
    1. Caroline Hillairet & Ying Jiao, 2012. "Credit Risk with asymmetric information on the default threshold," Post-Print hal-00663136, HAL.
    2. Caroline Hillairet & Ying Jiao, 2010. "Information Asymmetry in Pricing of Credit Derivatives," Papers 1002.3256, arXiv.org.
    3. Caroline Hillairet & Ying Jiao, 2010. "Information Asymmetry in Pricing of Credit Derivatives," Working Papers hal-00457456, HAL.

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