Assessing Credit with Equity: A CEV Model with Jump to Default
AbstractUnlike 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 firmâs capital structure are avoided. Default is parsimoniously represented by equity value hitting the zero barrier. Default can be either predictable, according to a CEV process that yields a positive probability of diﬀusive default and enables the leverage eﬀect, or unpredictable, according to a Poisson-process jump that implies non-zero credit spreads for short maturities. Easy cross-asset hedging is enabled. By means of a carefully specified pricing kernel, we also enable analytical credit-risk management under possibly systematic jump-to-default risk.
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Bibliographic InfoPaper provided by University of Verona, Department of Economics in its series Working Papers with number 24.
Date of creation: Sep 2005
Date of revision:
Equity; Corporate Bonds; Credit Default Swaps; Constant-Elasticity-of-Variance (CEV) Diffusion; Jump to Default;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-05-20 (All new papers)
- NEP-CFN-2006-05-20 (Corporate Finance)
- NEP-FMK-2006-05-20 (Financial Markets)
- NEP-RMG-2006-05-20 (Risk Management)
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