Assessing Credit with Equity: A Cev Model with Jump to Default

CentER Discussion Paper No. 2005-27

45 Pages Posted: 26 Feb 2005

See all articles by Alessandro Sbuelz

Alessandro Sbuelz

Catholic University of Milan - Department of Mathematics, Quantitative Finance, and Econometrics; Bocconi University - CAREFIN - Centre for Applied Research in Finance

Luciano Campi

London School of Economics & Political Science (LSE)

Simon Polbennikov

Tilburg University

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

Sbuelz, Alessandro and Campi, Luciano and Polbennikov, Simon, Assessing Credit with Equity: A Cev Model with Jump to Default (November 2005). CentER Discussion Paper No. 2005-27, Available at SSRN: https://ssrn.com/abstract=675061 or http://dx.doi.org/10.2139/ssrn.675061

Alessandro Sbuelz (Contact Author)

Catholic University of Milan - Department of Mathematics, Quantitative Finance, and Econometrics ( email )

largo A. Gemelli 1
I-20123 Milan
Italy
+39 02 7234 2345 (Phone)
+39 02 7234 2671 (Fax)

HOME PAGE: http://ppd.unicatt.it/docenti/alessandro_sbuelz

Bocconi University - CAREFIN - Centre for Applied Research in Finance

Via Sarfatti, 25
Milan, 20136
Italy

Luciano Campi

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Simon Polbennikov

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands