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Business cycle and credit risk modeling with jump risks

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  • Jang, Bong-Gyu
  • Rhee, Yuna
  • Yoon, Ji Hee

Abstract

We develop a structural model that incorporates both macroeconomic risks and firm-specific jump risks. We derive analytic formulas for default probability, equity price, and CDS spreads. Based on reasonably calibrated parameters, we find that our model could predict actual default probabilities and overcome the underestimation of credit risks, especially for firms with high credit ratings, which has been one of the major limitations of the currently available structural models. The structural model highlights that macroeconomic factors are important in modeling credit risks and that default probabilities and CDS spreads could be dependent on the current economic state.

Suggested Citation

  • Jang, Bong-Gyu & Rhee, Yuna & Yoon, Ji Hee, 2016. "Business cycle and credit risk modeling with jump risks," Journal of Empirical Finance, Elsevier, vol. 39(PA), pages 15-36.
    • Handle: RePEc:eee:empfin:v:39:y:2016:i:pa:p:15-36
    DOI: 10.1016/j.jempfin.2016.08.001
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    3. Ballestra, Luca Vincenzo & Pacelli, Graziella & Radi, Davide, 2020. "Modeling CDS spreads: A comparison of some hybrid approaches," Journal of Empirical Finance, Elsevier, vol. 57(C), pages 107-124.

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