On modelling credit risk using Arbitrage Free Models
AbstractBy examining the distribution of state prices obtained from binomial versions of Jarrow and Turnbull (1995), Lando (1998) and Duffie and Singleton (1999), we are able to suggest which credit risk parameters are of critical interest. We find that it appears worthwhile to parameterize credit risk since even the simplest parameterized model obtains large changes in the distribution of state prices when compared to a non-parameterized model. Similarly we find large differences in the distribution of state prices as we add correlation and moderate changes as we add time varying recovery rates. Finally, the choice between the RM or RF recovery assumption appears innocuous, but the choice between RT and these two recovery assumptions is not.
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Bibliographic InfoPaper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2000-08.
Length: 24 pages
Date of creation: Jul 2001
Date of revision: Mar 2000
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Credit risk; credit derivatives; binomial lattice; arbitrage free pricing;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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- 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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Finance and Economics Discussion Series
96-29, Board of Governors of the Federal Reserve System (U.S.).
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