Stochastic Volatility Effects on Defaultable Bonds
This paper studies the effect of introducing stochastic volatility in the first-passage structural approach to default risk. The impact of volatility time scales on the yield spread curve is analyzed. In particular it is shown that the presence of a short time scale in the volatility raises the yield spreads at short maturities. It is argued that combining first passage default modelling with multiscale stochastic volatility produces more realistic yield spreads. Moreover, this framework enables the use of perturbation techniques to derive explicit approximations which facilitate the complicated issue of calibration of parameters.
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Volume (Year): 13 (2006)
Issue (Month): 3 ()
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- Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-64, May.
- Merton, Robert C, 1974.
"On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,"
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- Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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