Credit Derivatives and Risk Aversion

Advances in Econometrics Year: 2008, Vol. 22, pp. 275 - 291, 2008

15 Pages Posted: 4 Jul 2009

See all articles by Tim Leung

Tim Leung

University of Washington - Department of Applied Math

Ronnie Sircar

Princeton University - Department of Operations Research and Financial Engineering

Thaleia Zariphopoulou

University of Texas at Austin (Mathematics and IROM)

Date Written: December 1, 2007

Abstract

We discuss the valuation of credit derivatives in extreme regimes such as when the time-to-maturity is short, or when payoff is contingent upon a large number of defaults, as with senior tranches of collateralized debt obligations. In these cases, risk aversion may play an important role, especially when there is little liquidity, and utility-indifference valuation may apply. Specifically, we analyze how short-term yield spreads from defaultable bonds in a structural model may be raised due to investor risk aversion.

Keywords: credit risk, utility maximization, defaultable bonds, indifference price

JEL Classification: M41, M44, J33, G13

Suggested Citation

Leung, Tim and Sircar, Ronnie and Zariphopoulou, Thaleia, Credit Derivatives and Risk Aversion (December 1, 2007). Advances in Econometrics Year: 2008, Vol. 22, pp. 275 - 291, 2008, Available at SSRN: https://ssrn.com/abstract=1427532

Tim Leung (Contact Author)

University of Washington - Department of Applied Math ( email )

Lewis Hall 217
Department of Applied Math
Seattle, WA 98195
United States

HOME PAGE: http://faculty.washington.edu/timleung/

Ronnie Sircar

Princeton University - Department of Operations Research and Financial Engineering ( email )

Princeton, NJ 08544
United States

Thaleia Zariphopoulou

University of Texas at Austin (Mathematics and IROM) ( email )

CBA 5.202
Austin, TX 78712
United States