Advanced Search
MyIDEAS: Login

Risk Disaggregation And Credit Risk Valuation In The Merton Like Way

Contents:

Author Info

  • Hayette Gatfaoui

    (The University of Paris 1 - Panthéon-Sorbonne)

Abstract

Recent literature focuses on the systematic and specific components of credit risk (Dichev [1998], Wilson [1998], Jarrow, Lando & Yu [2001]). It is currently assumed, at least implicitly, that financial data are all subject to one latent systematic factor (Jarrow, Lando & Yu [2001], Lucas, Klaassen, Spreij & Straetmans [2001]). In this paper, we formalize those insights by distinguishing between one systematic risk component and one idiosyncratic risk component in credit risk valuation. Such a risk disaggregation allows us to state an analytical formula for valuing European type calls. Given that corporate debt could be priced through a call on the firm assets value and with a strike corresponding to the debt’s value at maturity, we then apply this distinction to the risky debt valuation framework stated by Merton (1974). A closed form formula of a bond’s price is first deduced, leading then to an analytical expression of the related credit spread. We consequently give an explicit formulation for the market risk, namely the undiversifiable part, and the idiosyncratic risk, namely the diversifiable part, of the default risk characterizing any corporate bond. This methodology allows us to highlight some valuation errors concerning default risk valuation when identifying only one source of risk. In accordance with Wilson (1998), the results show that credit risk valuation techniques have to take into account the two main sources of risk affecting financial assets in the market. The correlation between defaults being captured through the market component of every corporate bond or every debt security.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://128.118.178.162/eps/fin/papers/0308/0308007.html
Download Restriction: no

Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0308007.

as in new window
Length: 1 pages
Date of creation: 25 Aug 2003
Date of revision:
Handle: RePEc:wpa:wuwpfi:0308007

Note: Type of Document - HTML; prepared on PC; to print on HP/PostScript; pages: 1 ; figures: included. Only the abstract is available since this document is published in the Journal of Risk Finance.
Contact details of provider:
Web page: http://128.118.178.162

Related research

Keywords: option pricing credit risk default probability;

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

No references listed on IDEAS
You can help add them by filling out this form.

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Hayette Gatfaoui, 2004. "Idiosyncratic Risk, Systematic Risk and Stochastic Volatility: An Implementation of Merton's Credit Risk Valuation," Research Paper Series 123, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. Hayette Gatfaoui, 2003. "How Does Systematic Risk Impact US Credit Spreads? A Copula Study," Risk and Insurance 0308002, EconWPA.
  3. Gatfaoui Hayette, 2004. "Idiosyncratic Risk, Systematic Risk and Stochastic Volatility: An Implementation of Merton’s Credit Risk Valuation," Finance 0404004, EconWPA.
  4. Lin, William & Sun, David, 2006. "Diversification with idiosyncratic credit spreads: a pooled estimation on heterogeneous panels," MPRA Paper 37288, University Library of Munich, Germany, revised Jun 2007.
  5. Sun, David & Tsai, Shih-Chuan, 2013. "Diversifying Risks in Bond Portfolios: A Cross-border Approach," MPRA Paper 44767, University Library of Munich, Germany, revised 09 Jan 2014.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpfi:0308007. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.