Assessing Credit with Equity: A Cev Model with Jump to Default
CentER Discussion Paper No. 2005-27
45 Pages Posted: 26 Feb 2005
Date Written: November 2005
Abstract
Unlike in structural and reduced-form models, we use equity as a liquid and observable primitive to analytically value corporate bonds and credit default swaps. Restrictive assumptions on the firm's capital structure are avoided. Default is parsimoniously represented by equity value hitting the zero barrier either diffusively or with a jump, which implies non-zero credit spreads for short maturities. Easy cross-asset hedging is enabled. By means of a tersely specified pricing kernel, we also make analytic credit-risk management possible under systematic jump-to-default risk.
Keywords: Equity, Corporate Bonds, Credit Default Swaps, Constant-Elasticity-of-Variance (CEV) Diffusion, Jump to Default
JEL Classification: G12, G33
Suggested Citation: Suggested Citation
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