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Assessing Credit with Equity: A CEV Model with Jump to Default

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  • Campi, L.
  • Polbennikov, S.Y.
  • Sbuelz, A.

    (Tilburg University, Center for Economic Research)

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    Abstract

    Unlike in structural and reduced-form models, we use equity as a liquid and observable primitive to analytically value corporate bonds and credit default swaps.Restrictive assumptions on the .rm.s capital structure are avoided.Default is parsimoniously represented by equity value hitting the zero barrier either diffusively or with a jump, which implies non-zero credit spreads for short maturities.Easy cross-asset hedging is enabled.By means of a tersely speci.ed pricing kernel, we also make analytic credit-risk management possible under systematic jump-to-default risk.

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    Bibliographic Info

    Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2005-27.

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    Date of creation: 2005
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    Handle: RePEc:dgr:kubcen:200527

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    Web page: http://center.uvt.nl

    Related research

    Keywords: Equity; Corporate Bonds; Credit Default Swaps; Constant-Elasticity-of-Variance (CEV) Diffusion; Jump to Default;

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    References

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    1. Damiano Brigo & Marco Tarenghi, 2009. "Credit Default Swap Calibration and Equity Swap Valuation under Counterparty Risk with a Tractable Structural Model," Papers 0912.3028, arXiv.org.
    2. Beckers, Stan, 1980. " The Constant Elasticity of Variance Model and Its Implications for Option Pricing," Journal of Finance, American Finance Association, vol. 35(3), pages 661-73, June.
    3. Emanuel, David C. & MacBeth, James D., 1982. "Further Results on the Constant Elasticity of Variance Call Option Pricing Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(04), pages 533-554, November.
    4. 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.
    5. Schroder, Mark Douglas, 1989. " Computing the Constant Elasticity of Variance Option Pricing Formula," Journal of Finance, American Finance Association, vol. 44(1), pages 211-19, March.
    6. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-64, May.
    7. Guha, R. & Sbuelz, A., 2003. "Structural RFV: Recovery Form and Defaultable Debt Analysis," Discussion Paper 2003-37, Tilburg University, Center for Economic Research.
    8. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
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    Cited by:
    1. Maclachlan, Iain C, 2007. "An empirical study of corporate bond pricing with unobserved capital structure dynamics," MPRA Paper 28416, University Library of Munich, Germany.

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