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A General Structural Approach For Credit Modeling Under Stochastic Volatility

Author

Listed:
  • Escobar, Marcos

    () (Department of Mathematics, Ryerson University)

  • Friederich, Tim

    () (Chair of Mathematical Finance, Technische Universität München)

  • Seco, Luis

    () (Department of Mathematics, University of Toronto)

  • Zagst, Rudi

    () (Chair of Mathematical Finance, Technische Universität München)

Abstract

This paper assumes a structural credit model with underlying stochastic volatility combining the Black/Cox approach with the Heston model. We model the equity of a company as a barrier call option on its assets. The assets are assumed to follow a stochastic volatility process; this implies an equity model with most documented stylized facts incorporated. We derive the price of this option under a general framework where the barrier and strike are different from each other, allowing for richer financial applications. The expression for the probability of default under this framework is also provided. As the calibration of this model gets much more complex, we present an iterative fitting algorithm with which we are able to nicely estimate the parameters of the model, and we show via simulation the consistency of the estimator. We also study the sensitivity of the model parameters to the difference between the barrier and strike price.

Suggested Citation

  • Escobar, Marcos & Friederich, Tim & Seco, Luis & Zagst, Rudi, 2011. "A General Structural Approach For Credit Modeling Under Stochastic Volatility," Journal of Financial Transformation, Capco Institute, vol. 32, pages 123-132.
  • Handle: RePEc:ris:jofitr:1462
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    Cited by:

    1. Marcos Escobar & Peter Hieber & Matthias Scherer, 2014. "Efficiently pricing double barrier derivatives in stochastic volatility models," Review of Derivatives Research, Springer, vol. 17(2), pages 191-216, July.

    More about this item

    Keywords

    Barrier Option; Structural Black-Cox; Stochastic Volatility; Method of Moments;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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