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Interactions Between Market and Credit Risk: Modeling the Joint Dynamics of Default-Free and Defaultable Bond Term Structures

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  • Roger WALDER

    (University of Lausanne, FAME and Banque Cantonale Vaudoise)

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    Abstract

    The objective of this paper is to model and estimate simultaneously the joint dynamics of default-free and defaultable bond term structures. Defaultable bond prices are modeled in an intensity based framework along the lines of Duffie and Singleton (1999) with state variables following an affine diffusion. Our special interest lies in the benefits of introducing various kinds of interdependencies in the drifts and the diffusions of the factors driving the term structure dynamics. We obtain consistent and efficient estimates of the model parameters using the efficient method of moments (EMM) of Gallant and Tauchen (1996).

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    File URL: http://www.swissfinanceinstitute.ch/rp56.pdf
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    Bibliographic Info

    Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp56.

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    Date of creation: Nov 2002
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    Handle: RePEc:fam:rpseri:rp56

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    Keywords: Term Structure Model; Credit Risk; Defaultable Bond; Effient Method of Moments;

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    References

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    1. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
    2. Jean -Luc Prigent & Olivier Renault & Olivier Scaillet, 2000. "An Empirical Investigation in Credit Spread Indices," Working Papers 2000-59, Centre de Recherche en Economie et Statistique.
    3. Gallant, A. Ronald & Tauchen, George, 1996. "Which Moments to Match?," Econometric Theory, Cambridge University Press, vol. 12(04), pages 657-681, October.
    4. Yacine Ait-Sahalia, 1995. "Testing Continuous-Time Models of the Spot Interest Rate," NBER Working Papers 5346, National Bureau of Economic Research, Inc.
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    23. 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.
    24. Ahn, Dong-Hyun & Gao, Bin, 1999. "A Parametric Nonlinear Model of Term Structure Dynamics," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 721-62.
    25. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
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