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Credit market equilibrium theory and evidence: Revisiting the structural versus reduced form credit risk model debate

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  • Jarrow, Robert A.

Abstract

There are two competing paradigms for modeling credit risk: the structural and reduced form models. This paper applies our knowledge of credit market equilibrium to this debate. We show that credit markets have asymmetric information in the borrowing and lending relationship which influence equilibrium prices. Reduced form models are consistent with asymmetric equilibrium models, but structural models are not. This implies that structural models should not be used for pricing, hedging, or risk management.

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  • Jarrow, Robert A., 2011. "Credit market equilibrium theory and evidence: Revisiting the structural versus reduced form credit risk model debate," Finance Research Letters, Elsevier, vol. 8(1), pages 2-7, March.
    • Handle: RePEc:eee:finlet:v:8:y:2011:i:1:p:2-7
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    4. Carlos Serrano-Cinca & Begoña Gutiérrez-Nieto & Luz López-Palacios, 2015. "Determinants of Default in P2P Lending," PLOS ONE, Public Library of Science, vol. 10(10), pages 1-22, October.
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    7. Jumbe, George, 2023. "Credit Risk Assessment Using Default Models: A Review," OSF Preprints ksb8n, Center for Open Science.
    8. Biao Guo & Qian Han & Doojin Ryu, 2013. "The Number of State Variables for CDS Pricing," Working Papers 2013-10-14, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University.
    9. Chen, Shou & Jiang, Xiangqian & He, Hongbo & Zhou, Xi, 2020. "A pricing model with dynamic repayment flows for guaranteed consumer loans," Economic Modelling, Elsevier, vol. 91(C), pages 1-11.
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