CREDIT RISK PREMIA - NUS Singapore University College 信用风险溢价-新加坡国立新加坡大学.pptVIP

CREDIT RISK PREMIA Kian-Guan Lim Singapore Management University Prepared for the NUS Institute of Mathematical Sciences Workshop on Computational Finance (29 – 30 Aug 2005) Ideas Defaultable bond pricing Recovery method Credit spread Intensity process Affine structures Default premia Model risk Reduced Form Models Jarrow and Turnbull (JF, 1995) Jarrow, Lando, Turnbull (RFS, 1997) RFV (recovery ? of face value) at T Price of defaultable bond price under EMM Q where default time ?* = inf {s ? t: firm hits default state} Comparing with Structural Models (or Firm Value Models) Advantages Avoids the problem of unobservable firm variables necessary for structural model; the bankruptcy process is exogenously specified and needs not depend on firm variables Easy to handle different short rate (instantaneous spot rate) term structure models Once calibrated, easy to price related credit derivatives Disadvantage Default event is a surprise; less intuitive than the structural model Assuming independence of riskfree spot rate r(s) and default time r.v. ?* T-step transition probability Q(t,T)=Q(t,t+1).Q(t+1,t+2)….Q(T-1,T) If qik(t,T) is ikth element of Q(t,T), then Prt(?*T) = 1- qik(t,T) Q(.,.) is risk-neutral probability Advantage Using credit rating as an input as in CreditMetrics of RiskMetrics Disadvantage Misspecification of credit risk with the credit rating Hazard rate model – basic idea Lando (RDR, 1998) When recovery ? of par only is paid at default time t?*T instead of at T For a n-year coupon bond with 2n coupons  Recovery – another formulation discrete time approximation where hs? is the conditional probability at time s of default within (s,s+?) under EMM Q given no default by time s Under RMV (recovery of market value just prior to default) Duffie Singleton (RFS, 1999) Rt : default-adjusted short rate Credit spreads Relation with earlier studies Given ?. After obtaining ?i(t,T), Per period spot rate is ln [?i(t,T+1)/?i(t,T)