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 behaviour assumed for asset values, can be circumvented by considering discontinuous asset prices. In this paper the authors resort to a pure jump process of the Variance-Gamma type. First the authors 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, they show that it also circumvents the diffusive structural models difficulties over longer horizons. Particularly, it corrects for the underprediction of low-risk spreads and the overprediction of high-risk ones. Then the authors extend the model to joint default, resorting to a recent formulation of the VG multivariate model and without superimposing a copula choice. They 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 full calibration without the equicorrelation assumption, but still in a parsimonious way. As an example of the default assessments which the calibrated model can provide, the authors price an FtD swap.

Single and joint default in a structural model with purely discontinuous asset prices

LUCIANO, Elisa;SEMERARO, PATRIZIA
2010

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 behaviour assumed for asset values, can be circumvented by considering discontinuous asset prices. In this paper the authors resort to a pure jump process of the Variance-Gamma type. First the authors 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, they show that it also circumvents the diffusive structural models difficulties over longer horizons. Particularly, it corrects for the underprediction of low-risk spreads and the overprediction of high-risk ones. Then the authors extend the model to joint default, resorting to a recent formulation of the VG multivariate model and without superimposing a copula choice. They 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 full calibration without the equicorrelation assumption, but still in a parsimonious way. As an example of the default assessments which the calibrated model can provide, the authors price an FtD swap.
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http://www.tandf.co.uk/journals/rquf
Filippo Fiorani; Elisa Luciano; Patrizia Semeraro
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Utilizza questo identificativo per citare o creare un link a questo documento: http://hdl.handle.net/2318/104944
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