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Single and joint default in a structural model with purely discontinuous assets

Author

Listed:
  • Filippo Fiorani
  • Elisa Luciano
  • Patrizia Semeraro

Abstract

Structural models of credit risk are known to present both vanishing spreads at very short maturities and a poor spread fit over longer maturities. The former shortcoming, which is due to the diffusive behavior assumed for asset values, can be circumvented by considering discontinuous assets. In this paper we resort to a pure jump process of the Variance-Gamma type. First we calibrate the corresponding Merton type structural model to single-name data for the DJ CDX NA IG and CDX NA HY components. By so doing, we show that it circumvents also the diffusive structural models difficulties over longer horizons. In particular, it corrects for underprediction of low risk spreads and overprediction of high risk ones. Then we extend the model to joint default, resorting to a recent formulation of the VG multivariate model and without superimposing a copula choice. We fit default correlation for a sample of CDX NA names, using equity correlation. The main advantage of our joint model with respect to the existing non diffusive ones is that it allows calibration without the equicorrelation assumption, but still in a parsimonious way. As an example of the default assessments which the calibrated model can provide, we price a FtD swap.

Suggested Citation

  • Filippo Fiorani & Elisa Luciano & Patrizia Semeraro, 2007. "Single and joint default in a structural model with purely discontinuous assets," Carlo Alberto Notebooks 41, Collegio Carlo Alberto.
  • Handle: RePEc:cca:wpaper:41
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    File URL: http://www.carloalberto.org/assets/working-papers/no.41.pdf
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    References listed on IDEAS

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    1. Elisa Luciano & Wim Schoutens, 2006. "A multivariate jump-driven financial asset model," Quantitative Finance, Taylor & Francis Journals, vol. 6(5), pages 385-402.
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    Cited by:

    1. Fang Liu & Jing-Sheng Song, 2012. "Good and Bad News About the ( S , T ) Policy," Manufacturing & Service Operations Management, INFORMS, vol. 14(1), pages 42-49, January.
    2. Antonio Romero-Medina & Matteo Triossi, 2013. "Games with capacity manipulation: incentives and Nash equilibria," Social Choice and Welfare, Springer;The Society for Social Choice and Welfare, vol. 41(3), pages 701-720, September.
    3. Flavia Barsotti, 2012. "Optimal Capital Structure with Endogenous Default and Volatility Risk," Working Papers - Mathematical Economics 2012-02, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
    4. Elisa Luciano, 2007. "Copula-Based Default Dependence Modelling: Where Do We Stand?," ICER Working Papers - Applied Mathematics Series 21-2007, ICER - International Centre for Economic Research.

    More about this item

    Keywords

    credit risk; structural models; Lévy asset prices; default probability; joint default.;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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